Broadcom shares rise as it adds more customers for custom AI chips. Can the stock’s momentum continue?

Broadcom (AVGO -5.15%) Shares jumped after the company reported record revenue in its fiscal fourth quarter ended Nov. 3 and said it is developing custom artificial intelligence (AI) chips for a number of large customers. The sharp rise in the share price has resulted in the stock recording a gain of over 100% in the year to date.

Let’s take a closer look at the company’s recent results and comments to see if the stock’s momentum can continue.

AI opportunity

More than the results, it was Broadcom CEO Hock Tan’s comments that excited investors and helped push the stock higher. He said each of his three major “hyperscaler” customers (those with massive data centers) plans to deploy a million XPU clusters (AI chips) by 2027. Including XPUs and networking equipment, Broadcom’s addressable market among these three customers could be between $60 billion and $90 billion in fiscal 2027 alone.

Additionally, Tan said two more hyperscaler customers are in advanced development of their own artificial intelligence (AI) chips, which could significantly expand the addressable market. Tan said Broadcom plans to turn these companies into revenue-generating customers by fiscal 2027.

Apple could be one of those new customers, as it was recently reported that the iPhone maker is working with Broadcom on a new AI server chip, codenamed Baltra, to help run its AI applications in the cloud. According to the reports, the company plans to complete the chip design within the next year.

As for Broadcom’s results, revenue rose 51% to $14.05 billion in the quarter, but was only 11% higher when accounting for contributions from the acquisition of VMware, which acquired the company in November 2023 has, disregards $14.09 billion, compiled by the London Stock Exchange Group.

Semiconductor solutions revenue increased 12% year-over-year to $8.2 billion. Within the segment, network revenue led the way, increasing 45% to $4.5 billion, with custom AI network revenue increasing 158%.

Mobile revenue rose 7% year over year to $2.2 billion due to higher content. Apple was rumored to be parting ways with Broadcom for its own Bluetooth and Wi-Fi chip, although the company said it continues to “work very closely with this customer to create multi-year roadmaps for various technologies where we are leaders in, including RF, Wi-Fi, Bluetooth, sensing and touch.

Broadcom said server storage connectivity revenue rose 20% to $992 million from its low point six months ago and that it expects further growth. Broadcom revenue fell 51% to $465 million, but Broadcom believes that this area has now bottomed out as the company won some large orders this quarter. Industrial sales, which fell 27%, represent only about 1% of sales at $173 million. The company expects a recovery in the second half of the year.

Infrastructure software revenue increased 196% to $5.8 billion, primarily driven by the VMware acquisition. Sales were flat from the previous quarter as the company said some stores were pushed back into the first quarter. As a result, Q1 software revenue is expected to increase 41% year over year and 11% quarter over quarter.

Turning to profitability, adjusted earnings per share (EPS) increased from $1.11 to $1.42 in the quarter, adjusted for the prior 10:1 stock split. That was above the analyst consensus of $1.38. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) rose 65% year over year to $9.1 billion.

Broadcom generated operating cash flow of $5.6 billion and free cash flow of $5.5 billion in the quarter, while the company had operating cash flow of $20 billion and free cash flow of $19 billion for the full year. 4 billion US dollars. The company ended the fiscal year with nearly $19.3 billion in cash and cash equivalents and $67.6 billion in debt resulting from its earlier $69 billion acquisition of VMware.

In terms of guidance, the company forecast first-quarter revenue of about $14.6 billion – just above the consensus of $14.57 billion – and would represent growth of about 22%. Management expects adjusted EBITDA to be approximately 66% of sales, or approximately $9.6 billion.

Image source: Getty Images.

Can the stock’s momentum continue?

Broadcom’s fiscal fourth-quarter results were solid but not spectacular, with revenue growing just 11% once you exclude the boost from the earlier VM acquisition.

Meanwhile, first-quarter revenue forecasts were essentially in line with analyst expectations. These aren’t typically the kind of results that cause the stock to rise, unless it was suppressed and expectations were low, which clearly wasn’t the case for Broadcom, whose stock fell this year leading up to the report showed a strong performance.

However, investors are clearly excited about the possibilities the company offers with bespoke AI, which seems quite extensive given its increasing customer acquisition. As companies look for alternatives NvidiaTo prevent the company from becoming too powerful, developing custom chips through Broadcom appears to be becoming a preferred strategy.

However, caution should also be exercised when it comes to Broadcom’s comments. The first is that obviously some of the addressable market that Hock Tan was talking about will still go towards Nvidia’s GPUs. Second, one of those customers is probably ByteDance, which sees the possibility that TikTok could be banned in the US. That raises major doubts about how this customer could increase their spending on AI chips.

Following the price increase, Broadcom is now trading at a forward price-to-earnings (P/E) ratio of under 30. That’s higher than in recent years, although investors are clearly looking to future accelerated growth.

AVGO PE Ratio (Forward 1 Year) data from YCharts.

I continue to like Broadcom’s AI capabilities, but after this recent big run-up in share price, I would consider not pursuing the stock any further. There are still questions about Apple’s possible loss of business and the fallout from TikTok, which could impact ByteDance and the distribution of its custom chips.