Broadcom reported an earnings beat Thursday, driven by strong sales of its AI products and VMware software. But management’s guidance for the current quarter disappointed investors, sending shares of the chipmaker down nearly 7% in the after market. This is too harsh of a reaction to an otherwise solid print. Revenue increased 47% year over year to $13.07 billion, beating analysts’ forecasts of $12.97 billion, according to estimates compiled by LSEG, formerly Refinitiv. Excluding the contribution from VMWare, Broadcom’s sales rose 4% year over year. Adjusted earnings per share (EPS) grew 18% from last year to $1.24, which exceeded expectations of $1.20. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) came in at $8.22 billion in the quarter, beating the $7.8 billion predicted by Wall Street. Broadcom Why we own it : Broadcom is a high-quality semiconductor and software company run by an incredible CEO in Hock Tan, who is best known for his value-creating M & A strategy. We view Broadcom as one of the biggest AI beneficiaries through its networking and custom chip businesses. The stock trades at a much more reasonable price-to-earnings ratio relative to other chip stocks. The company also has a shareholder-friendly capital allocation strategy with its dividends and buybacks. Competitors : Marvell Technology, Advanced Micro Devices and Nvidia Last buy : Oct. 3, 2023 Initiation date : Aug. 2, 2024 Bottom line Broadcom continues to deliver on our thesis. Its AI-related business continues to grow at a fast clip and the increase to the full-year outlook further proves this is one of the best AI chip stories in the market. The VMWare integration is also performing incredibly well, but we always had little doubt since the company has an excellent track record of acquiring strong businesses that can generate both revenue and cost synergies. The only weakness in the story right now is in the legacy semiconductor business. But CEO Hock Tan said on the earnings call that in aggregate its markets have reached a bottom and are on the road to recovery. When asked about how big the recovery could be during the Q & A section, Tan sounded confident about it returning at least to prior levels. “And like all previous cycles, my sense … is we will get up back to the level we used to be. There’s no reason at all why it doesn’t,” he said about the non-AI semi business. “And given the rate of booking … I dare say, even put a thought in your mind that as AI permeates enterprise, enterprises all across digital natives, you need to upgrade service. You need to upgrade storage. You need to upgrade networking, connectivity across the entire ecosystem,” Tan explained. Although Tan was hesitant to provide a timing around the next upcycle, he said it could meet or even surpass prior cycles because of the storage and workload needs of AI computing. The investment thesis for Broadcom is intact: AI revenues are strong, non-AI semi revenues are mostly bottoming, and the VMWare integration is exceeding all expectations. But with the stock down more than 6% and back trading in the low $140s after what looks like to be a beatable guide, Thursday’s sell-off is an opportunity to buy gradually on any additional weakness. Just leave room in the position in case volatility persists over the next month and a half. We reiterate our 1 rating and $190 price target. Quarterly commentary Semiconductor solutions revenue grew nearly 5% year over year to $7.27 billion, missing expectations, as strength in AI-related sales could not offset ongoing cyclical weakness in revenue from enterprises and telecommunications companies. AI and non-AI-networking: Total revenue increased 43% year over year to $4 billion, driven by about $3.1 billion in AI networking and custom AI accelerator sales to hyperscaler customers that are scaling up and scaling out their AI clusters. The revenue split was about one-third networking and two-thirds compute (custom silicon). Broadcom operates an Ethernet network, which differs from Nvidia’s InfiniBand solutions. On the custom chip side, Broadcom said sales grew 3.5 times year over year. The company doesn’t call out its customers out by name, but it’s widely believed that Club names Alphabet and Meta Platforms — and more recently, TikTok parent ByteDance — are the main customers for these custom AI accelerators. Tan sees AI revenues increasing 10% sequentially to over $3.5 billion in the fourth quarter. The legacy semiconductor businesses were weak, perhaps more than expected given the miss in the quarter. Wireless : Revenue increased 1% year over year to $1.7 billion. In the fourth quarter, Tan said he expects revenue to surge over 20% sequentially to reflect the launch of a next-generation device from a North American customer. He is speaking, of course, about Apple ahead of its Sept. 9 event, when the company is expected to reveal its new AI-powered iPhone. Although Tan didn’t budge his full-year wireless outlook of relatively flat year over year, this could be a conservative call and fiscal 2025 sales will be strong because Apple is about to embark on a big new upgrade cycle. Server and storage connectivity : Sales fell 25% year over year to $861 million. But the recovery Tan called for beginning in the second half of its fiscal year is playing out as the results improved 5% sequentially. That recovery will continue in the fourth quarter, as Tan expects revenue to grow by a mid-to-high single digit percentage sequentially and be down by a high single digit percentage year over year. Broadband : Sales remained under pressure due to a pause in telco and service provider spending, falling 49% year over year to $557 million. Tan pushed out the bottoming timeline to the beginning of 2025 from the second half of its fiscal year. Industrial : Sales fell 31% year over year for this small business but Tan said it may have hit a bottom in the third quarter. Broadcom’s other segment, infrastructure software , posted revenue that beat expectations, growing 200% year over year to $5.8 billion. VMware continued its improving trend, with revenue of $3.8 billion in the quarter, up from $2.7 billion last quarter and $2.1 billion two quarters ago. Even better, in traditional Broadcom fashion, the company is reducing VMWare’s associated costs. Operating expense in the quarter was $1.3 billion, down from $1.6 billion in the second quarter. With revenues growing and expenses falling, VMWare’s profitability profile is significantly improving. When Broadcom first bought the business in November 2023, management set a target of $8.5 billion in adjusted EBITDA within three years of the acquisition. Tan moved up that timeline on the earnings call when he said it is on the path to achieving or exceeding this goal in the next fiscal year 2025. Capital allocation On the headline, Broadcom generated about $4.8 billion in free cash flow in the quarter, a big miss versus the consensus estimate of about $6.5 billion. However, Broadcom generated $5.3 billion in free cash flow when excluding restructuring and integration cash costs in the quarter. The company paid $1.3 billion of withholding taxes related to net settled equity awards that vested in the quarter, resulting in the elimination of 8.4 million shares. Similar to the prior quarter, there were no formal share repurchases in the quarter as part of its buyback as the company prioritizes debt reduction related to the VMware acquisition. Once Broadcom gets its debt level back toward normal levels, expect hefty buybacks. Outlook For the fourth quarter of its fiscal 2024, Broadcom expects revenue to be approximately $14 billion, which is a touch lower than the Street consensus estimate of $14.1 billion. By segment, semiconductor revenue is expected to be $8 billion while infrastructure software sales are expected to be about $6 billion. The semi number is a slight miss versus expectations, and the difference is probably due to the non-AI business lines because AI sales are humming. Broadcom raised its full-year AI revenue forecast to $12 billion, up from prior guidance of over $11 billion. Although Broadcom didn’t provide explicit guidance for fiscal 2025, Tan said on the call he expects AI revenues to show strong growth next year. Despite a slightly soft revenue outlook, fourth-quarter profitability looks very strong. Management guided adjusted EBITDA to approximately 64% of projected revenue, or $8.96 billion. That’s a beat compared to Street estimates of $8.84 billion. Based on the third-quarter results and fourth-quarter guide, the implied full-year revenue outlook is about $51.5 billion, which is in-line with the consensus estimate and slightly above Broadcom’s prior full-year outlook of $51 billion. (Jim Cramer’s Charitable Trust is long AVGO. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Broadcom reported an earnings beat Thursday, driven by strong sales of its AI products and VMware software. But management’s guidance for the current quarter disappointed investors, sending shares of the chipmaker down nearly 7% in the after market. This is too harsh of a reaction to an otherwise solid print.