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Broadcom's Competition Is Nipping at Its Heels

March 02, 2012 | About:
Broadcom (BRCM) has been a strong performer in my opinion, but it has gotten ahead of itself. Fourth quarter results announced on January 31 showed that the company’s year-on-year quarterly revenue fell by about 6.5% with all sectors of its business suffering. A lot of that suffering had much to do with weaker sales to Apple (AAPL) and other wireless device producers. The best performing of its business sectors was mobile and wireless, but here, revenues fell by 4% and 7%, respectively.

I think profitability has been excellent at Broadcom. Overall its margins held up pretty well, with an operating margin of 24.89% and a profit margin of 20.91%. Earnings per share were around 5% better than the market was expecting, though at $0.68 per share were around 4% lower than the same quarter last year. Analysts now expect this year’s earnings to turn out at $2.77 compared to $1.65 last year. This is a tough target to beat. The company is going to have to do a stellar job selling chipsets to customers and work on getting larger and larger contracts. While its sales team is top-notch, a lower hurdle would be more desirable. I think investors could be surprised to the downside.

The earnings multiple is reasonable. At $38, shares trade on a trailing price to earnings ratio of 22.9, and a forward ratio of 12.3. This represents Broadcom’s fast growth potential over the next year.

Broadcom’s better than expected results were driven by its business with both Apple (AAPL) and Samsung, as the companies’ smartphones sold well through the fourth quarter. Particularly, Apple’s sparkling results on the quarter underlined how well the company’s products have been received by the market place. The iPhone 4S is a key product for Broadcom, and the company continues to be a key purchasing Atheros last year it put Qualcomm in direct competition with Broadcom, particularly in the iPad and tablet market. Qualcomm (QCOM) reported its revenue had grown by 40% during the same quarter, with net income increasing by 20% and earnings per share by 14%. At $62, Qualcomm shares are changing hands at a trailing price to earnings ratio of 23.68. With earnings for the year ending September 2012 of $3.75 per share penciled in by analysts, Qualcomm shares are trading at a forward price to earnings ratio of 14.96. I think the company is a strong competitor; however, both companies can co-exist successfully.

I think Qualcomm continues to outdo Broadcom on the profitability front. Qualcomm’s operating margin is posted at 34.4%, and its profit margin of 27.57% is over twice that of Broadcom’s.

Qualcomm is also making a push into the connectivity market, which is likely to challenge Broadcom’s position. Qualcom’s processors have a lower power consumption rate than others, and consumers may see this as a positive as battery life increases. This is a negative for Broadcom as sales could weaken. Certain customers have a strong need for lower power consumption processors. I’d like to see Broadcom innovate its way into this space.

Broadcom shares are unattractive at this time, in my opinion. Broadcom shares have been pushed higher by its better than expected results as well as market reaction to Apple’s positive outlook. At $38, the bounce of around 35% from last year’s lows looks far enough for now.

Though in the longer term Broadcom shareholders may be rewarded for hanging on, in the short term further share price gains rely on Apple’s performance and Broadcom warding of the increasing challenge of Qualcomm. It’s also possible, of course, that Apple could use its importance to Broadcom to pressure prices, which would in turn dent the good margins from which the company currently benefits. At $38, I believe that Broadcom shares are a sell. I would be a buyer around $30 per share.

About the author:

Dividend King
I am primarily an investor interested in creating passive income streams through dividends. I focus on finding and analyzing dividend paying stocks, MLPs and REITs that are a good fit for income investors.

I practice Judaism and my faith is very important to me. I visit family in Israel once a year, but I am educated and work in the United States where I hold an MBA and a bachelor’s in English. I am a patient man, enjoy wine but am not a connoisseur, and I listen more than I speak.

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