This Stock is Not Cheap, But Will Continue to Grow

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Growth did not come easy for chip stocks in 2012. Aside from a few notable performances from names such as Qualcomm (NASDAQ: QCOM), the entire sector was ravaged by poor spending. Then again, from Qualcomm, this was expected. However, no one anticipated Broadcom (NASDAQ: BRCM) would have the year that it did.

Not only has Broadcom beaten estimates each quarter, the company is doing so at a record pace, including $2 billion in revenue in Q3 – its highest ever for one quarter. Also working in its favor is its close relationship with both Apple (NASDAQ: AAPL) and Samsung, an advantage that some of its peers don't enjoy. Ahead of its Q4 report on Tuesday, Broadcom wants to prove the best is yet to come.

Building on a Strong Q3, Can it Outperform?

The company is in the midst of becoming a remarkable turnaround story – except nobody is talking about it. Although the stock is not cheap when compared to Qualcomm (P/E of 18 vs. 26), Broadcom still has plenty of room to run.

As noted, that Broadcom has close ties to Apple and Samsung presents the company with a combined 50% exposure to the smartphone market – an advantage that served it well in its third quarter, during which Broadcom beat Street earnings estimates by 3 cents – posting 79 cents per share on revenue of $2.13 billion.

Not only did this represent 10% revenue growth, but as noted in the opening, this was the first time in the company’s history that it exceeded the $2 billion mark in one quarter. Too, this was the third consecutive quarter of annual revenue growth.

By comparison Broadcom is outperforming rivals such as Texas Instruments (NASDAQ: TXN). Although the company had an underwhelming 2012 and a disappointing Q4 report, shares of TI are trading near 52-week highs. In its recent Q4 report, Texas Instruments posted revenue of $2.98 billion -- down 12% sequentially and down 13% year-over-year.

Worse, this marked the fifth consecutive quarter of declining revenue. And the company is not expecting much improvement in Q1 as it issued revenue guidance that represents 6% sequential decline. This means that Texas Instruments expects to continue to lose market share to (among others) Broadcom and market leader Qualcomm, which will report on its Q4 on Wednesday.

For that matter, in Qualcomm’s most recent quarter, not only did revenues soar 18% year-over-year to $4.87 billion, but the company reported a 1% jump in chip shipments. Essentially, Qualcomm is guiding higher as Texas Instruments continues to revise lower. That Qualcomm expects higher shipments in chips certainly bodes well for Broadcom’s growth momentum.

Then again, Qualcomm’s recent performance highlights a glaring concern about Broadcom’s valuation. Does it deserve to be priced higher than the marker leader? This is what Broadcom’s management will have to prove during the Q4 announcement.

Expectations for the Quarter – Will Apple Hurt?

The Street is expecting earnings of 52 cents per share, which will represent roughly 16% growth year over year. However, that estimates have come down 3 cents over the past 90 days is a concern. Nonetheless, 52 cents per share is a target that Broadcom is expected to beat with relative ease. For the fiscal year, analysts are projecting earnings to arrive at $2.01 per share.

The company is expected to post revenue of $2.07 billion, which will be good enough for 14% year-over-year growth. That’s not exciting when compared to Qualcomm’s 18%, but it’s much better than Texas Instruments. Plus it would also present 4% sequential improvement in what has been a very difficult market for chips.

For the full fiscal year, revenue is projected to come in at $7.98 billion. As noted, Broadcom has posted solid revenue growth over the past five quarters and has shown consistent profit growth over the past eight. So the question is not whether or not the company will beat, but it’s by how much? Then again, if there is one concern, it’s with Apple’s recent performance.

As noted, while Broadcom’s relationship with Apple is a significant benefit, it can also be an “achilles heel.” The sweet quarter that Apple was expected to report turned out sour. Apple posted broadly in-line revenue of $54.5 billion, but possibly it was softer depending on which data point used. Too, ahead of the report, there were concerns about Apple’s supply chain issues.

Plus, investors were displeased with the iPhone unit number reported by Apple. Buy-side analysts were looking for 50 million, Apple posted 47.8 million (although Apple had one fewer week in its fiscal calendar than it had last year). With Broadcom being one of Apple’s major suppliers, it begs the question if there are any links and similarities ahead of Broadcom’s Q4 report?

Bottom Line

There is a lot to like about Broadcom as the company is the midst of a remarkable turnaround. But the stock is far from cheap - not when compared to Qualcomm. Then again, I don’t see any roadblock to further growth.

That the company is growing revenues in the face of stiff competition and a tough macro environment suggests that its investments in sales and marketing are doing just fine, although Apple’s recent decline is certainly worth watching. However, for patient investors looking for a solid play on chips, shares should approach the $40 mark by the second half of this year.

Richard Saintvilus is long AAPL and has no position in the other stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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