Transformative VMware Integration And AI Expansion Drive Revenue And Margin Growth

Key Takeaways

• Acquisition of VMware and focus on virtualization significantly boost revenue and margins, projecting continued earnings improvement.
  
• Strategic moves in AI and effective cash flow management enhance revenue potential, market share, and shareholder value.
  
• Integration of VMware incurs one-time costs, potentially impacting margins, with hyperscale customer reliance, declining non-AI revenue, and substantial debt posing financial risks.

Catalysts

Designs, develops, and supplies various semiconductor devices with a focus on complex digital and mixed signal complementary metal oxide semiconductor based devices and analog III-V based products worldwide.

• Broadcom's acquisition of VMware has been a transformative influence, significantly enhancing revenue and operating margin. The completion of integration and focus on data center virtualization are expected to continue driving revenue and improve net margins.
  
• The surge in AI-related revenue, driven by custom AI accelerators (XPUs) and networking components, indicates strong growth potential. This is likely to increase overall revenue and enhance earnings through fast-growing semiconductor revenue.
  
• Upcoming deployment of next-generation 3nm XPUs for hyperscale customers suggests a continued upward trajectory in AI revenue, likely boosting long-term revenue and contributing to earnings growth.
  
• Broadcom anticipates a vast opportunity in AI with an addressable market for XPUs and networking projected between $60 billion to $90 billion by 2027. Gaining substantial market share here could significantly impact revenue growth.
  
• Strategic debt reduction and dividend increases reflect robust cash flow management, which could enhance shareholder value and positively affect earnings per share, contributing to stock valuation.

Broadcom Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Broadcom's revenue will grow by 16.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 12.0% today to 40.1% in 3 years time.
• Analysts expect earnings to reach $32.8 billion (and earnings per share of $6.59) by about December 2027, up from $6.2 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $39.6 billion in earnings, and the most bearish expecting $24.8 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 45.2x on those 2027 earnings, down from 182.1x today. This future PE is greater than the current PE for the US Semiconductor industry at 30.0x.
• Analysts expect the number of shares outstanding to grow by 2.03% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.12%, as per the Simply Wall St company report.

Broadcom Future Earnings Per Share Growth

Risks

• Broadcom's integration of VMware resulted in significant one-time costs, which, if mismanaged, could affect operating margins and long-term profitability.
  
• The company's heavy reliance on a few hyperscale customers for AI revenue creates concentration risk, potentially leading to volatility in semiconductor revenues if customer dynamics change.
  
• Decline in non-AI semiconductor revenue, down by 23% year-on-year, suggests potential ongoing weakness in traditional markets, which could impact overall revenue diversification and stability.
  
• Broadcom has significant debt from the VMware acquisition, with $69.8 billion of gross principal debt, potentially increasing financial risk and impacting net earnings if macroeconomic conditions or interest rates change unfavorably.
  
• The potential for AI revenue growth is substantial, but Broadcom acknowledges variability and non-linear growth, which introduces risk to consistent revenue and earnings forecasts, possibly affecting investor confidence.

Valuation

• The analysts have a consensus price target of $235.74 for Broadcom based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $300.0, and the most bearish reporting a price target of just $171.6.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $81.8 billion, earnings will come to $32.8 billion, and it would be trading on a PE ratio of 45.2x, assuming you use a discount rate of 8.1%.
• Given the current share price of $239.68, the analyst's price target of $235.74 is 1.7% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.