EUR 850.00 For Business Accounts Only

Morningstar | Broadcom Not Immune to U.S-China Trade Tensions, but Long-Term View Unchanged

Narrow-moat Broadcom reported second-quarter results relatively in line with our expectations, and management tempered their outlook for the full year. The reduced guidance was primarily attributed to geopolitical tensions, chiefly between the U.S. and China, and while we were unsurprised by the direction of the guidance, we were slightly taken aback by the magnitude. While the addition of Huawei to the U.S. Entity List is the starkest example of the trade dispute, recent results imply, and management has corroborated this, that the uncertainty extends beyond that one customer and the contagion is reverberating throughout the semiconductor supply chain. Still, our long-term view remains unchanged, and as we articulated in a recent note, the crux of our investment thesis on Broadcom and other large-cap semi-names is that the brinksmanship between the U.S. and China is not a structural erosion of end-market demand, but rather negotiating chips that will ultimately be resolved. Even if Huawei and other Chinese original equipment manufacturers, or OEMs, remain in the crosshairs, we believe other OEMs will be able to pick up the slack eventually; with end-market demand, supported by secular trends, driving the need for increased connectivity and lower latency. Adjustments for near-term weakness are offset by the time value of money and other puts and takes in our model, leaving our $300 fair value estimate intact. With shares down in hours, we see an attractive entry point for investors to own this semiconductor stalwart.

Second-quarter revenue of $5.5 billion is a 10% year-over-year increase, while adjusted EPS increased 7% to $5.21. Management now expects the second half of the year to be in line with the first half, in lieu of the previously announced recovery. Fiscal 2019 sales guidance was decreased to $22.5 billion, with the reduction entirely attributable to a $2 billion cut in the outlook for the semiconductor business, now expected to be $17.5 billion.

Management didn't hesitate to note that the Huawei ban was the primary catalyst for the relative weak demand and risk aversion in the market. CEO Hock Tan indicated that prior to the beginning of the third quarter (beginning of May), buying trends in the market seemed conducive to the previously forecast second-half recovery. Still, he emphasized that Huawei was not the sole source of weakness. According to him, Huawei was a roughly $900 million customer for Broadcom in fiscal 2018. While we believe the Huawei run-rate was on track to increase in 2019 (in light of reports suggesting the Chinese firm had been stockpiling critical components prior to the ban) there are clearly other OEMs that are reducing inventories or delaying product ramps.

Bright spots in the quarter included the previously announced RF front-end supply agreement with a North American OEM (known to be Apple), and continued strength in the infrastructure software business following the CA Technology acquisition. These developments give us confidence that the firm has a runway for growth supplying RF, Wi-Fi and other connectivity chips as 5G and Wi-Fi 6 standards proliferate, and also benefitting from the recurring revenue of a sticky software business, with a free cash flow that will continue to facilitate strategic acquisitions.