Supply-chain, wireless woes might offset Broadcom’s (AVGO) COVID-driven gains

Anticipating a mixed impact on its business from the virus outbreak, Broadcom (NASDAQ: AVGO) is pursuing a multi-pronged approach with stress on investments in mission-critical solutions and effective cost management. Given the rapid adoption of remote working, the tech firm can expect a spike in demand in the second half, mainly from cloud and telecom companies.

At the same time, the San Jose-based semiconductor solutions provider is concerned about the continuing supply-chain constraints and weakness in the wireless business in the current quarter, which is typically a strong period due to seasonal factors. So, the executives took a cautious stance while issuing the near-term guidance, which naturally fell short of expectations dampening the otherwise upbeat investor mood.

Stock Peaks

Nevertheless, the recent wave of cloud migration and digital transformation paints an optimistic picture of the semiconductor industry. No wonder, Broadcom’s stock surged to a record high this week – at a time when most Wall Street firms are struggling to regain lost ground – and stayed on an upward trajectory since then, justifying analysts’ consensus rating of strong buy.

Broadcom’s balance sheet, which has remained strong over the years, got a further fillip when the company ended the April-quarter with a record cash balance of $9 billion. Shareholders should benefit from the impressive liquidity position, in the form of hassle-free dividend payments. Also, with the integration of Symantec finally over, there will be a moderation in operating expenses this year.

Sees Wireless ‘Reset’

With Apple (AAPL) reportedly delaying the production of its new smartphone, Broadcom’s concerns of a ‘reset’ in the wireless business can be linked to a potential drop in chip supplies to the iPhone maker, which accounts for a major share of its wireless chip sales. But those impacts can be balanced by leveraging the strong network chip market that thrives on sustained spending by cloud providers and telecom firms.

The long-term strategy for the wireless business remains intact, with the steady uptick in 5G phone content serving as a catalyst, though the transition to the high-speed network is going to take a long time.

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While interacting with analysts at the second-quarter conference call Broadcom’s CEO Hock Tan said, “In Q3 we would normally expect to see a double-digit sequential uplift in revenue from the ramp of the next-generation phone at our large North American mobile phone customer. However, this year we do not expect to see this uptick in revenue until our fourth fiscal quarter. So accordingly, we expect our wireless revenue in Q3 would be down sequentially as it was down in Q2.”

Long Lead Times

The company’s new-gen Trident and Tomahawk switching chips have been quite popular among data-center customers. While demand conditions are encouraging, disruptions in production/test facilities at home, and abroad have resulted in unusually long lead times. The resultant delay is impacting deliveries and the trend is expected to continue beyond the current quarter.

But lead times have been like that in the past, due to factors like capacity constraints and logistics issues. The disciplined manner in which Broadcom deals with the situation helps it reduce the risk of inventory buildup – by making sure that products are made strictly as per orders and not based on speculation.

Mixed Q2

At $5.14 per share, adjusted earnings were slightly below the prior-year levels and in line with estimates in the second quarter because margins came under pressure from muted top-line growth. The core Semiconductor Solutions segment recorded a modest decline, which was more than offset by double-digit growth in Infrastructure Software revenues. As a result, total revenues moved up 4% annually to $5.7 billion and exceeded the forecast.

“Very fortunately, in our view, our products are very strong franchises in their own rights. And so I would say we see our customers are very, very willing and able, in many situations, to work with us as we work through our supply chain challenges. In other words, the demand has not been seem to be perishable.”

Hock Tan, CEO of Broadcom

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After a short-lived pull-back from the peak in mid-March, amid the COVID-induced selloff, Broadcom’s shares made steady gains and hit an all-time high following Thursday’s earnings report. Currently trading close to the levels seen at the beginning of the year, the stock has gained 18% in the past twelve months.