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Why Broadcom Is Rallying

- By Shubham Jaipuria

Chipmaker Broadcom Inc. (AVGO) has been proving the bears wrong.

Rallying on the semiconductor industry's recent optimism, Broadcom is one play that stands to benefit from greater consumer technology adoption. Increased cloud computing expenditures are boosting chipmakers as companies like Alphabet Inc. (GOOGL) (GOOG) and Amazon.com Inc. (AMZN) continue to ramp up their data center spending.

"More than half our consolidated revenue is benefiting from strong cloud and enterprise data center spending," CEO Hock Tan said on a call with analysts. Moreover, increased smartphone penetration and the emergence of internet of things will play in the company's favor. Broadcom's chips are in Samsung (005930.KS) and Apple's (AAPL) phones. With Apple's latest product launch, the chipmaker's sales are expected to increase significantly.

The semiconductor giant released its third-quarter results on Sept. 6. Revenue grew from $4.46 billion to $5.06 billion, just shy of the Street's consensus of $5.07 billion. Non-GAAP earnings increased to $4.98 per share, beating analyst estimates of $4.83. Moreover, free cash flow grew 52% from the year-ago period to $2.1 billion, comprising 42% of revenues.

Sales for the enterprise storage business grew 70% as the acquisition of Brocade helped drive the top line. On the other hand, the company's wireless business, which multiple investors are bullish on, saw little change at $1.3 billion. The wired segment was up 4% to $2.3 billion.

Looking ahead, Broadcom expects fourth-quarter revenue of approximately $5.40 billion, while analysts guide for $5.35 billion. "This, [cloud and enterprise data center spending] coupled with a seasonal uptick in wireless, will drive our forecast revenue in the fourth quarter," Tan said.

Tan, who was praised for growing Broadcom to a $100 billion behemoth through a series of acquisitions, surprised the markets in July with a move to acquire CA Technologies for roughly $19 billion. Shares took a hit following the announcement on worries of lack of direction and motive for the acquisition.

The CEO defended his decision, saying, "When you look at the largest enterprises, which comprise CA key customers, these guys really have limited direct access to our mission-critical technology. In that lies what we think is a new and huge opportunity."

The company also announced a cash dividend payment of $1.75 per share, which is to be paid on Sept. 28.

Broadcom is currently trading with a price-earnings ratio of 8.92 compared to the industry median of 19.55. It has a forward price-earnings ratio of 11 compared with the industry median of 18.55, indicating the stock is currently significantly undervalued.

Moreover, the fundamentals are quite appealing as it currently has an operating margin of 22.8%, above the industry median of 6.76%. The net margin stands at 57.66%, above the industry median of 5.25%. All told, Broadcom appears to be an interesting bet given the current landscape of the semiconductor industry. GuruFocus also gave the company a profitabilty and growth rating of 8 out of 10.

Disclosure: I do not own any of the stocks mentioned.

This article first appeared on GuruFocus.