Broadcom’s solid quarter points to even more strength in the coming quarters

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Investing Club holding Broadcom (AVGO) reported strong fiscal fourth-quarter results Thursday after the closing bell. On the top line, revenue of $7.4 billion (+15% YoY) outpaced the $7.35 billion consensus. On the bottom line, diluted earnings of $7.81 per share (+23% YoY) edged out the $7.72 per share the Street was looking for.

“Broadcom concluded the year with record fourth quarter results driven by a rebound in enterprise, and continued strength from cloud and service provider demand. Our infrastructure software growth continues to be steady with our focus on strategic customers,” said CEO Hock Tan on the release. “With the strength and breadth of our IP portfolio, we continue to be able to uniquely deliver leading edge, best-in-class semiconductor solutions, and extend our leadership in our franchise markets.”

In addition to the headline results, adjusted gross margins of ~74.6% (+100bps YoY) edged out the 74.4% expected, while adjusted operating margin of ~59.2% (+290bps YoY) outpaced the 58.8% consensus.

The strong results were met with equally strong guidance as management expects FY1Q22 revenue of ~$7.6 billion, well ahead of the $7.2 billion expected coming into the print. Profitability is also projected to be better than expected as management is guiding for a 61.5% adjusted EBITDA margin, versus a 60% margin consensus coming into the print.

All that in mind, what’s better than better than expected results and guidance that tops expectations? How about that plus a 14% increase to the common stock dividend and $10 billion buyback, both of which were announced in conjunction with the release and provide a sense of the confidence management has in the strength we saw in this release sustaining into the future!

Broadcom reports its earnings in two segments: Semiconductor Solutions and Infrastructure Software.

Starting with Semiconductor Solutions, revenue of $5.634 billion (+17% YoY) edged out the $5.627 billion consensus and represented 76% of total revenue. Segment gross margin expanded to 70% (+170bps YoY) “driven by favorable product mix and content growth in next-generation products” across the product portfolio. Moreover, Broadcom’s operating leverage was on full display as that 17% segment revenue growth led to a 24% increase in operating profit, as segment operating margin expanded to 56% (+350bps YoY). Looking ahead, the team expects the segment strength to continue and guided for revenue to once again grow 17% YoY. Excluding wireless, segment revenue is expected to increase 28% YoY.

Within the segment, Networking revenue advanced 13% YoY to $1.9 billion, representing 34% of segment revenue. On the call, Tan attributed the double-digit growth to strong campus switching, cloud and 5G infrastructure demand. Tan also called out strong demand for custom ASIC silicon solutions from hyperscale cloud customers, which now represent 20% of networking revenue and noted that the hyperscale footprint now extends beyond TPUs (which the company designs for customers such as Alphabet) and works with “multiple cloud customers.” Tan added that the sub-segment is “firing on all cylinders” in the current quarter with growth expected to accelerate to close to 30% YoY.

Server storage connectivity revenue jumped 21% YoY to $815 million, representing 15% of segment revenue. On the call, Tan called out continued share gains due to expanding leadership in next-gen products and a recovery in enterprise spending. Here too, management sees current quarter growth accelerating to ~30% on an annual basis.

Broadband revenue surged 29% YoY to $872 million, representing 16% of segment revenue. Management cited an industry leading portfolio of end-to-end solutions that, bolstered by the company’s software stack allow Broadcom to offer more bandwidth and faster data speeds, allowing Broadcom to sustain market leadership. Looking ahead, management expects to once again see double-digit percentage revenue growth.

Wireless revenue increased 21% YoY to $1.8 billion, representing 32% of segment revenue. On the call, Tan called out the launch of a customers’ next-generation phone in the quarter. That customer would be Apple – but you’ll never hear the team admit that because rule number one of being an Apple supplier is you don’t talk about being an Apple supplier. Looking ahead, the team the strength to continue, however, while sales are expected to grow sequentially, they will be flat to up single-digits annually as they lap strong prior year results.

Lastly, Industrial revenue of $197 million represented 3% of segment revenue with the team seeing strong demand from electric vehicle OEMs, robotics, factory automation and health care. Notably, Tan called out that as a result of strong resales ($232 million in the quarter), channel inventory has declined to below one month. Looking ahead, management expects the strong resales to continue at the strong level seen in the reported quarter.

Infrastructure Software revenue of $1.774 billion (+8% YoY), edged out the $1.724 billion consensus and represented 24% of total revenue. Segment gross margin expanded to 90% (+19bps YoY) while the operating margin expanded to 70% (+166bps YoY). Similar to the Semiconductor Solutions segment, we saw operating leverage here as the 8% segment sales growth resulted in an 11% increase in operating profit.

Within the segment, Tan called out 19% YoY growth at Brocade, which benefited from the “strong enterprise recovery.” Excluding Brocade, segment revenue was up 6% YoY.

Importantly, over 90% of bookings came from recurring subscriptions and maintenance. This is an important dynamic to be mindful of because as members know, investors reward recurring revenue growth with expanded valuation multiples. So, as this segment grows over time, thanks to management’s prior pivot to focus on software acquisitions (versus the historic hardware focus), we wouldn’t be surprised to see the company’s price-to-earnings multiple expand along with the earnings growth – resulting in a one-two punch for stock price appreciation.

Speaking to the momentum Broadcom is seeing on the software front, Tan also took a moment to call out 15% backlog growth, to $14.9 billion, with average contract duration extending from 2.6 years to 2.9 years. This amounts to an annual recurring revenue rate of $5.2 billion per year, up 5% from the year ago period.

Taking a look at cash flow performance — which we monitor closely due to management’s very shareholder friendly policy of returning ~50% of its prior year cash flow to shareholders via dividends (a commitment reiterated during the call) — while operating cash flow of $3.541 billion came in a bit light versus the $3.82 billion consensus and free cash flow of $3.453 billion was bit below the $3.785 billion consensus, the results nonetheless represent an annual of operating cash flow and free cash flow increase of $193 million and $207 million, respectively. And again, the team did increase the quarterly dividend by 14% (to $4.10), with plans to maintain that payout throughout the year, subject to board approval. Annualizing this, we get a payout of $16.40 representing a dividend yield of ~2.6% based on the ~$620 share price we are seeing in the afterhours session. 

All in, this was a very solid quarter from Broadcom, and we expect to see the strength continue in coming quarters as enterprise spending comes back online and software revenues increase. While investors had some concerns when management first pivoted their M&A focus to software, the concern was clearly unwarranted, and the stock’s valuation multiple has been rewarded as a result.

That said, the year-to-date run should not be viewed as simply the result of multiple expansion. In fact, while the stock is now up ~41% on the year (including the after-hours move), the 19.9x forward p/e multiple is only up ~21% from the 16.4x multiple shares traded at coming into the year. The magnitude of that expansion is also likely an overestimate, as we expect 12-month forward earnings estimates to move higher following this release thanks to the above-consensus sales and margin guidance, not to mention the $10 billion buyback authorization (meaning that based on a $620 share price, shares are more than likely trading below that 19.9x multiple).

The point being, the strength we have seen in shares this year is more attributable to strong fundamental performance than to technical multiple expansion. The story has gotten better since the beginning of the year. As a result, shares are not that much more expensive from a valuation perspective than they were coming into the year despite the outsized price appreciation.

Another way to think about how expensive the stock is, is through the dividend – especially because many investors own Broadcom for the income. As noted above, the increase tonight brings the stocks dividend yield to ~2.6%, a level that is actually right on par with the stocks 5-year historic dividend yield.

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