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Morningstar | Broadcom Records Another Solid Quarter; Shares Remain Attractive Relative to Unchanged FVE

Broadcom reported in line fiscal third-quarter results while providing a fourth-quarter outlook slightly ahead of our prior expectations. The firm’s wireless segment was negatively impacted by share loss for certain RF parts, as customers were able to utilize lower capability parts in certain stock-keeping units. CEO Hock Tan was adamant that the cadence in adoption by leading OEMs of Broadcom’s premium RF parts should resume in material fashion next year, particularly as 5G capabilities begin to be adopted. In contrast, Broadcom’s other major segments exhibited solid year-over-year growth, illustrating the breadth of the company’s offerings. Tan also aggressively defended the recent CA Technology acquisition, citing the potential for Broadcom to sell its swathe of server products (networking, storage, connectivity) to CA’s predominantly enterprise customer base. We remain positive on the financial benefits of the deal (modest premium, high profitability, and solid cash generation), while the strategic ones mentioned by Tan could take some time to be fully appreciated. Nevertheless, we think the market negatively overreacted in the wake of the CA deal announcement and view shares as attractive relative to our unchanged $300 fair value estimate for narrow-moat Broadcom.

Third-quarter revenue was $5.06 billion, up 13% year over year and 1% sequentially. We note the wireless segment was roughly flat at $1.3 billion, with offsetting share gains and losses. Wired infrastructure was flat sequentially at $2.3 billion, reflecting continued robust demand from cloud customers offset by cyclical headwinds in the broadband business that management expects to subside in 2019. Enterprise storage sales were up 8% quarter over quarter to $1.25 billion, thanks to robust enterprise IT spending and solid contributions from Brocade’s fiber channel switch business. We note this segment would still have exhibited year-over-year growth sans Brocade. Broadcom’s adjusted gross margins were 67.3%, up 70 basis points sequentially due to a slightly more favorable product mix.

Management expects fourth-quarter sales to be up 7% sequentially at a midpoint of $5.4 billion, which implies full-year top-line growth of 18%. Healthy spending by cloud vendors and enterprise IT should drive growth in wired and storage, respectively. Broadcom has been aiding cloud providers to design custom chips for offloading compute applications, such as Google’s TPU for Artificial Intelligence inferencing tasks. Consequently, this subsegment of wired has outgrown the broader wired business and should persist as demand for these types of chips increases. We remain positive on Broadcom’s powerhouse networking, RF filter, and connectivity portfolios, and believe the inclusion of CA’s mission-critical products should bolster the firm’s cash generation potential to fuel future accretive acquisitions.