Morgan Stanley recently turned bullish on Broadcom (AVGO) stock. On November 19, Morgan Stanley upgraded Broadcom stock and increased its price target and recommendations. The news pushed up Broadcom’s stock price by 2.13%, which closed at $317.70 yesterday.
Moreover, Broadcom stock hit a new high on November 19. The stock price is trading 2.4% lower than its 52-week high of $325.67, and around 46% higher than its 52-week low of $217.61.
According to a November 19 CNBC report, Morgan Stanley analyst Craig Hettenbach upgraded the firm’s recommendation on Broadcom from “equal-weight” to “overweight.” Hettenbach also lifted Broadcom’s one-year price target to $367 from $298. This price target was 15.5% higher than Tuesday’s closing price. In a client note, Morgan Stanley stated that Broadcom stock is a buying opportunity.
Was Morgan Stanley correct to upgrade Broadcom stock? Is Broadcom stock a “buy” amid its challenges? Let’s look at the headwinds facing this semiconductor giant.
Broadcom faces a high debt burden
Morgan Stanley is bullish on Broadcom’s acquisitions, which have diversified its business. Hettenbach also foresees strong near-term demand for its software products. As reported by TheStreet on November 19, Morgan Stanley notified its clients that Broadcom “can build on its leadership position in semis while leveraging its strong [free cash flow] to diversify into software.”
Last year, Broadcom entered the software business with the purchase of CA Technologies for $19 billion. The acquisition of Symantec’s (SYMC) enterprise unit for $10.7 billion is Broadcom’s recent effort to expand into the software business.
The addition of Symantec’s enterprise unit could generate significant revenues and cost synergies for Broadcom. However, the acquisition would also pressure the company with added debt, particularly after the CA Technologies acquisition.
In September, Broadcom made a stock offering to repay its debt. However, we doubt that this offering would relieve Broadcom of its massive debt load. At the end of the third quarter, Broadcom had long-term debt of around $34.0 billion. However, Broadcom’s operating cash flows were only $2.42 billion, while its free cash flows stood at $2.31 billion.
In August, Moody’s Investors Service placed Broadcom’s ratings under review for a potential downgrade. According to Moody’s, the acquisition of Symantec’s enterprise security business would further increase its leverage.
Taking these factors into account, we’re unsure whether investors should invest in such a highly leveraged stock, although Morgan Stanley’s Craig Hettenbach is optimistic about the stock.
Broadcom stock: Sluggish earnings and a weak outlook
Broadcom’s earnings topped its estimates in the third quarter of fiscal 2019, which ended on August 4. Plus, its revenues missed its estimates. Its earnings grew 3.6% YoY (year-over-year) in the third quarter, but it fell around 1% from the preceding quarter. Although its total revenues rose about 9% YoY in the third quarter, they remained soft from the second quarter. Broadcom’s revenues have been declining sequentially in the last two quarters.
Chip giant Broadcom gave a cautious outlook for its fiscal year, which ends in October, amid ongoing trade war fears. Broadcom forecast lower-than-expected revenue of $22.5 billion for fiscal 2019. Moreover, analysts expect Broadcom’s sales growth to deplete in the near term. Broadcom stated that the demand for microchips is not likely to improve in the short term.
Broadcom is currently facing orders to suspend some of its deals with TV and modem makers. According to an October Reuters report, Broadcom is facing orders from antitrust regulators in the European Union. According to the order, the US chipmaker would have to suspend specific business deals amid investigations whether these deals hampered competition. These orders would impact Broadcom’s deals with six TV set-top box and modem makers.
Although Broadcom believes that this decision won’t impact its business, this development might increase investors’ concern regarding the stock.
Broadcom stock: Valuation
AVGO stock appears expensive with a price-to-earnings ratio of 14.94x for fiscal 2019, given the projected growth in its earnings. Analysts expect its adjusted EPS to grow 2.16% in fiscal 2019. Its earnings are expected to increase by 9.2% in fiscal 2020.
Broadcom has an enterprise-value-to-revenue ratio of 7.01x for fiscal 2019. However, its revenue growth looks weak going forward. Analysts expect its fiscal 2019 revenues to grow by 8.08% YoY and by 4.82% YoY in fiscal 2020.
Uncertainty around the US-China trade deal
The ongoing US-China trade war has severely dented Broadcom’s revenues, as many Chinese electronic devices use Broadcom’s chips. China’s telecom giant Huawei also accounted for about $900 million of Broadcom’s 2018 sales. Like Broadcom, chipmakers Qualcomm (QCOM), Micron (MU), and Intel (INTC) also generate significant revenues from China. The trade war also forced Broadcom to terminate its plans to acquire Qualcomm in March.
We believe a trade deal could give some respite to the chip stocks. Last month, President Trump and China reached phase one of the trade deal. There were also reports of the improving economic scenario and optimism around the trade deal.
According to a November 19 CNBC report, President Trump threatened to raise tariffs in China. During a meeting with the Cabinet on Tuesday, Trump stated, “If we don’t make a deal with China, I’ll just raise the tariffs even higher.” The continued uncertainty around the trade deal could accelerate fears among already-jittery investors. We believe a further increase in these tariffs on China would damage the global economy and sensitive semi stocks.
Broadcom stock reached its 52-week high yesterday, despite these challenges. Amid trade war uncertainties, we would suggest that risk-averse investors remain on the sidelines despite the Morgan Stanley upgrade.