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The Worst Is Over for Broadcom Stock—Can It Rally?

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Broadcom (AVGO) stock has grown at a sluggish pace this year. AVGO stock has underperformed many of its semiconductor peers through December 24. The chipmaker’s stock returns were also lower than the broader markets. Broadcom stock has returned only 27.2% year-to-date (or YTD).

In comparison, Broadcom’s close rivals Qualcomm (QCOM) and Intel (INTC) have risen 59.2% and 29.0%, respectively. Chipmaker Advanced Micro Devices (AMD) has returned 152.1% as of December 24. Among the other semiconductor stocks, Marvell (MRVL), Micron (MU), and Nvidia (NVDA) returned 64.5%, 74.7%, and 79.1%, respectively, this year. Year-to-date, the S&P 500 has gained 28.6%, and the VanEck Vectors Semiconductor ETF (SMH) has surged about 63.1%.

On December 24, Broadcom stock rose 0.3% and closed the trading day at $320.50. At this price, Broadcom’s market value was around $127 billion. Broadcom stock is trading 3.2% below its 52-week high, while it is trading 39.1% down from its 52-week low.

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Broadcom’s struggling chip business

Broadcom stock is witnessing weak growth amid a choppy chip demand scenario. A cyclical semiconductor downturn added to the company’s concerns. A decline in Apple’s (AAPL) iPhone sales also hurt Broadcom’s chip sales in fiscal 2019. Notably, Apple uses Broadcom chips for iPhones and other products. In its fourth quarter, which ended in September, Apple’s iPhone sales declined to $33.4 billion.

The prolonged US-China trade war has severely dented Broadcom’s chip demand. Broadcom generated about $900 million of sales from China-based telecom giant Huawei in 2018. However, the trade ban on Huawei in May due to the ongoing US-China trade war hurt Broadcom’s sales. Plus, the trade war ruined Broadcom’s plans to acquire Qualcomm in March.

During its quarter ending in October, Broadcom’s Semiconductor Solutions segment declined 8% year-over-year due to soft chip demand. Moreover, the semiconductor giant remains cautious about the wireless chip sales outlook for fiscal 2020. Broadcom also anticipates its wireless chip sales to Apple and Samsung to drop in fiscal 2020.

We believe that Broadcom’s concerns are over and expect the stock to grow in fiscal 2020. Let’s see how Broadcom can surprise the investors next year.

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Broadcom stock poised for a rally

We believe that chip demand is likely to improve in fiscal 2020. Broadcom CEO Hock Tan stated during its Q4 and fiscal 2019 earnings call that the semiconductor business would grow on a year-over-year basis in the second half of the fiscal year. Also, we believe the progress in the US-China trade deal can further improve the chip demand scenario.

Earlier this month, the trade war eased as the US and China reached their phase one agreement. According to the trade deal, the US withdrew its plans to hike tariffs on $156 billion of Chinese goods. Meanwhile, China agreed to buy additional US goods and services worth $200 billion over the next two years. China recently decided to reduce tariffs on over 850 imported products, including frozen pork and avocado, according to CNBC.

The US-China phase one agreement of the trade deal was a positive development for semiconductor players.

Broadcom is gaining revenues from the software space

Broadcom is making efforts to reduce its dependence on its chip business. Recently, Broadcom announced that it is trying to sell its RF wireless chip unit. Some investment firms believe that Apple could be the most suitable buyer for its radio-frequency unit.

Amid weakness in the chip business, Broadcom is looking at expanding into the software business for generating revenues. In the fourth quarter of fiscal 2019, its revenues grew around 6% year-over-year, led by acquisitions in the software business.

Its revenues also crushed Wall Street estimates and improved from the preceding quarter. The company expects to generate over $7 billion in infrastructure software revenues in fiscal 2020.

Broadcom’s acquisition of CA Technologies last year added significant revenues in fiscal 2019. The CA deal helped Broadcom meet the growing demand for infrastructure software solution needs.

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Last month, Broadcom acquired Symantec’s enterprise business for $10.7 billion. The acquisition of Symantec’s enterprise unit would generate over $2 billion in revenues in fiscal 2020. Further, the deal would bring cost synergies of about $1 billion next year after closing the Symantec’s deal, according to a November 4 report by CRN.

Broadcom’s fiscal 2020 outlook and analysts’ projections

For fiscal 2020, Broadcom expects revenues of $24.5 billion–$25.5 billion, around 11% higher year-over-year. Broadcom is upbeat about 2020 on the back of its software business and better-than-expected 5G adoption.

Broadcom continues to expand its operating margins organically. The company is targeting operating margins of 55% by fiscal 2022. Meanwhile, the company expects its operating margins and adjusted EBITDA to remain flat in fiscal 2020. The company expects adjusted EBITDA guidance of $13.75 billion (plus or minus $250 million) in fiscal 2020.

Further, the company plans to pay down about $4 billion in debt in fiscal 2020. We note that Broadcom has a high debt load due to back-to-back acquisitions. The company’s long-term debt rose to $30.0 billion in the quarter ending in October from $17.5 billion in the same quarter a year ago.

Broadcom CFO Tom Krause mentioned during the company’s Q4 and fiscal 2019 earnings call that he would focus on paying off its debts. Krause stated that starting in 2020, the excess cash after paying dividends would be utilized to pay down its debt.

Wall Street analysts expect Broadcom to support growth in fiscal 2020. Analysts anticipate Broadcom’s earnings to recover from its 2.26% year-over-year growth in fiscal 2019 to 8.85% year-over-year in fiscal 2020.

For fiscal 2021, analysts expect Broadcom’s earnings to improve by 9.96%. Wall Street analysts expect AVGO’s revenues to increase 10.8% year-over-year for fiscal 2020, versus 8.32% growth in fiscal 2019. However, analysts predicted that its sales could drop by 5.25% year-over-year in fiscal 2021.

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Analysts’ recommendations for Broadcom stock

Analysts have given a 12-month target price of $349.28 on AVGO stock. The average target price stands at a 9.0% premium to the current price at $320.50 on December 24. Out of 34 analysts covering AVGO, 22 analysts gave it a “buy” rating. Only 12 analysts gave AVGO “hold” ratings, and there were no “sell” ratings.

The bullish analysts include UBS, Citigroup, BMO Capital, J.P. Morgan, and Mizuho. These analysts and others recently raised their price target after Broadcom’s Q4 of fiscal 2019 results.

Reading the technical levels

AVGO’s 14-day RSI (relative strength index) score is 54.64. This indicates that the AVGO stock is neither “overbought” nor “oversold.” An RSI level above 70 indicates that a stock is in “overbought” territory. On the other hand, an RSI below 30 shows that a stock is in “oversold” territory.

On December 24, Broadcom stock closed near its Bollinger Band midrange level of $317.75. This value indicates that the stock is neutral.

Based on the moving average indicators, we believe that AVGO has an uptrend ahead. AVGO stock is trading above the moving averages, signaling an upcoming uptrend. The stock was 0.9%, 4.0%, and 8.9% above its 20-, 50-, and 100-day moving averages of $317.75, $308.20, and $294.20, respectively.

We believe that Broadcom is in a transformation phase. The semiconductor giant is trying to move from its strength as a chipmaker and diversify into the software space. Broadcom’s acquisitions have helped it offer its infrastructure software solutions to its customers. The company is also gaining strength from its adoption of 5G technology.

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