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Broadcom Inc (AVGO), the semiconductor maker, reported strong revenue and free cash flow results for its fiscal Q3 on Sept. 3. Moreover, management gave robust guidance for the next quarter. This means that AVGO stock is likely deeply undervalued today.
AVGO stock is at $137.00 as of the close on Friday, Sept 6, having fallen over 10% after the results came out. This is still over its six-month low of $120.45 on April 19. So, if this downward trend continues, the stock might have further to fall to test that low again.
Nevertheless, given how strong the company's free cash flow (FCF) and FCF margins came in during this fiscal quarter, AVGO stock looks too cheap. Based on my analysis it could easily be worth substantially more, up to $191.80 per share, or 40% more, and a minimum price target of 20.6% higher at $165.22 per share.
Strong Free Cash Flow (FCF) Results
Broadcom's revenue hit $13.07 billion for the quarter ended Aug. 4. That was higher than analysts' expectations by over $108 million, according to Seeking Alpha. Moreover, the company generated a record free cash flow (FCF) of $4.791 billion. That exceeds last year's Q3 FCF of $4.597 billion, a gain of $194 million or +4.2%.
Moreover, its FCF margin was strong at 36.65% (i.e. $4.791 billion/$13.072 billion in revenue). This was higher than last quarter's $4.448 billion in unadjusted FCF, which was 36% of revenue.
However, last year its FCF margin was higher at 51.8%, given that its revenue was much lower (see table above). Nevertheless, making an FCF margin of almost 37% is still a very good result, albeit lower than last year. This also seems to be a sustainable level for Broadcom and could drive its value higher.
For example, management reiterated its guidance that revenue this fiscal year ending Oct. 31, 2024, will exceed $51.5 billion. Analysts forecast that revenue next year will reach $60.34 billion. As a result, using a 37% FCF margin metric, results in a free cash flow (FCF) estimate of $22.3 billion in fiscal 2025 (i.e., ending Oct. 2025).
Target Price Estimate
One way to value the stock is to use an FCF yield metric. For example, in the last 12 months (LTM) Broadcom has generated $18.655 billion in FCF, according to Seeking Alpha. That represents 2.92% of its $637.7 billion market cap, i.e., a 2.92% FCF yield.
Over time, that FCF yield could improve to 2.50% as its FCF grows stronger. Therefore, dividing the $22.3 billion 2025 forecast by 2.5% results in a market value of $892 billion. That is 40% higher than today's $637.7 billion market cap.
In other words, AVGO stock could be worth 40% more than its price today of $137.00. That sets its price target at $191.80 per share.
However, just to be conservative, let's use a 2.90% FCF yield. That results in a market cap estimate of $769 billion (i.e., $22.3b/0.029 = $769b). This is still 20.6% higher than today's $637.7 billion market cap. This sets the minimum price target at $165.22 (i.e., 1.20x $137.00).
Analysts See AVGO Stock as Undervalued
Analysts also see AVGO stock as too cheap here. Their average price targets are much higher. For example, Barchart's survey shows a mean price target of $190.51 per share and Yahoo! Finance reports that the average of 31 analysts is $194.48 per share.
Moreover, AnaChart, a site that tracks sell-side analysts' price targets and how well they do, shows an average $170.65 price target for 27 analysts. That is still almost 25% higher than Friday's price of $137.00 and in between my two price targets of $165.22 and $191.80.
Moreover, two top analysts who cover AVGO stock have recently raised their price targets since earnings were released, according to AnaChart. The table below shows this.
It shows that Joseph Moore, the Morgan Stanley analyst, raised his target price to $180 from $165.80 one day ago. He has an excellent track record according to AnaChart, having hit his price targets 80% of the time.
In addition, Toshiya Hari, of Goldman Sachs, raised his target to $190 from $185 one day ago. His track record is also noteworthy, having met his price targets almost 87% of the time. Moreover, AnaChart ranks both of these analysts very highly in terms of overall performance on a timely basis.
The bottom line here is that Broadcom stock looks deeply undervalued. This is based on its strong revenue, free cash flow, FCF margin, management guidance and analysts' target price targets.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
