Broadcom: Conservative Accounting and Soft Earnings

Broadcom Inc. (NASDAQ:AVGO) is set to report its fiscal year 2024 earnings on April 28, following a quarter marked by significant growth in AI revenues and the successful integration of VMware. However, the market has been concerned about the potential impact of geopolitical uncertainties and market volatility on the company's earnings and stock performance. In this article, we will discuss how Broadcom's conservative accounting practices might explain its soft earnings and why AVGO stock remains a Buy heading into its earnings release.

Broadcom's estimates have been revised downwards due to the expected moderation in its topline growth. The company is expected to report fiscal year 2024 revenue of $51.6 billion, up 44% year-over-year, representing a significant deceleration from the 53.6% growth it posted last year. However, we would like to point out to investors that Broadcom's gross margins are estimated to remain stable, despite the moderation in its revenue growth. Notably, it's expected to post a gross margin of 37.1% for fiscal year 2024, an improvement from last year's 36.5%.



Moreover, its EBIT margin is also expected to remain resilient despite the supply chain and logistics snarls. Broadcom is projected to report an EBIT margin of 29.8% in fiscal year 2024, down from last year's 30.7%. Nevertheless, Broadcom could be further impacted in the first quarter of fiscal year 2025 given the recent COVID lockdowns in China. As a result, its EBIT margin estimates for the first quarter of fiscal year 2025 have been revised downwards to 28.1%, which could be its weakest performance over the past year. Hence, we think the recent retracement in AVGO stock had reflected these potential headwinds in China, given its importance to Broadcom's supply chain.

Broadcom is still expected to post robust FCF margins for fiscal year 2024 at 26.9%, up from fiscal year 2023's 25.4%. However, Broadcom's FCF growth could decelerate through fiscal year 2025. Notably, Broadcom's FCF growth estimate for fiscal year 2025 was revised markedly from 10.5% to 7.5%, which could impact AVGO stock's valuation. Therefore, it's hard to argue that the market has not reflected the macro and supply chain headwinds in Broadcom's business. But AVGO Stock Remains Reasonably Valued.



We can understand why some investors felt that AVGO stock is due for a significant correction. It's clear that AVGO stock has outperformed the Invesco QQQ ETF (QQQ), Microsoft (MSFT), and Google (GOOGL) stock. Therefore, the fear that the retracement could hit AVGO stock next is understandable. But investors should consider their worries in the context of its valuation. If we consider MSFT stock as reasonably valued at 3.4% NTM FCF yield, why wouldn't we think AVGO stock is reasonably valued at 4.1% NTM FCF yield? We must highlight that we don't consider AVGO stock undervalued. It seems fairly valued to us, and that still makes for a compelling thesis for AVGO stock. However, we need to size our exposure appropriately (if we add), given its valuation. Therefore, we think some investors have failed to accord sufficient credit to Broadcom's tremendous FCF machine.



Is AVGO Stock A Buy, Sell, Or Hold? AVGO stock is a Buy as it heads into its fiscal year 2024 earnings. Also, there could be another upside surprise that Broadcom has often used, and we have not discussed: stock repurchase. The Street expects management to announce a sizeable buyback program that could surpass its $90B announcement last year. Trim Tabs Asset Management articulated (edited):

Broadcom’s free cash flow and buybacks have definitely supported the company to a larger degree than its peers. Everything is coming under pressure right now, and investors are looking for names with high-quality and sustainable free-cash-flow profitability. Broadcom is at the top of that list. - Bloomberg

Therefore, Broadcom investors could be treated to a pleasant surprise if management decides to authorize a buyback that validates our interpretation of AVGO stock valuation. As such, we reiterate our Buy rating for AVGO stock heading into its fiscal year 2024 earnings.