EUR 850.00 For Business Accounts Only

Morningstar | Moving Parts Galore: Eventful 4Q and Future Strategy Don't Deter Our Positive View on Broadcom

Broadcom concluded fiscal 2018 on a high note as fourth-quarter revenue surpassed our expectations thanks to broad-based strength. Many chip peers have been plagued by the systemic weakness at Apple, yet Broadcom turned in solid wireless segment results as it had already contemplated short-term share loss at the smartphone titan. The firm recently closed its acquisition of CA Technologies, underscoring its proclivity for acquiring companies with best-of-breed offerings at attractive valuations and exiting noncore product lines to streamline the business and drive cost synergies and incremental cash flow. While CA is out of the firm’s predominantly semiconductor-heavy wheelhouse, management is confident in its ability to increase this latest revenue stream.

The earnings call featured a whirlwind of material updates from CEO Hock Tan, including two new reporting segments (semiconductor solutions and infrastructure software), the elimination of quarterly guidance (only annual), and a structural alteration of CA’s business model from one of perpetual licenses to a fully ratable subscription model to better compete with SaaS alternatives. On the whole, the focus on full-year forecasts in lieu of quarter-to-quarter variability is better in line with the longer-term view we take with Broadcom and its competitors, while we find the CA transformation intriguing. As we digest the full impact of these changes, our initial analysis of narrow-moat Broadcom’s color on its end markets and fiscal 2019 guidance leads us to reiterate our $300 fair value estimate. The shares rose 5% during after-hours trading, but we continue to see an attractive margin of safety.

Fourth-quarter revenue was $5.44 billion, up 12% year over year and 8% sequentially. The wireless segment was $1.7 billion, down 5% due to RF share loss at key customers such as Apple and Samsung. Despite the share loss, Tan noted wireless was better than expectations thanks to upside volume of legacy phone generations at Apple. Furthermore, Tan expects a substantial recovery in the second half of 2019 as Broadcom takes share back for the next generation of smartphones. Wired infrastructure grew 3% year over year to $2.2 billion, reflecting continued robust demand from cloud customers in the networking and computing offload business offset by cyclical headwinds in the broadband business that management expects to subside in 2019. The networking and compute portion represented two thirds of the wired segment and grew 22% year over year.

Enterprise storage sales were up 1% quarter over quarter to $1.3 billion, thanks to robust enterprise IT spending and solid contributions from Brocade’s fiber channel switch business (acquired last year). Sans Brocade, enterprise storage grew double digits year over year. Broadcom’s adjusted gross margins were 68.4%, up 110 basis points sequentially due to a slightly more favorable product mix. For 2018, sales grew 18% to $20.85 billion, as the inclusion of Brocade and organic growth in wireless and server storage connectivity more than offset broadband weakness.

Management expects fiscal 2019 revenue to be $24.5 billion, which implies another year of 18% growth thanks to the inclusion of CA. Meanwhile, the firm increased its quarterly dividend target by 51% to $2.65, thanks to management’s confidence in the sustainability of the healthy level of free cash flow from operations generation (up 50% in fiscal 2018 to $8.2 billion). 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.