Why we're raising our price target on Broadcom despite sell-off

Broadcom reported strong quarterly results after the bell on Wednesday, but it didn't deliver enough bullish guidance to push the stock higher. According to estimates compiled by LSEG, revenue in the second quarter of fiscal 2026, which ended May 3, was $22.19 billion; this was a slight miss of the $22.27 billion consensus estimate. On an annual basis, revenue increased by 48%. LSEG data showed adjusted earnings per share (EPS) rose 54% to $2.44, beating expectations of $2.40. Adjusted EBITDA rose 52% in the quarter to $15.24 billion, beating FactSet's estimate of $15.06 billion. A measure of operating profitability, EBITDA is an abbreviation for earnings before interest, taxes, depreciation, and amortization. Why we have it Broadcom is a high-quality semiconductor and software company led by an incredible CEO, Hock Tan. The company is a major beneficiary of AI through its networking and custom chip businesses. It also has a shareholder-friendly capital allocation strategy with dividends and buybacks. Competitors: Marvell Technology, Advanced Micro Devices, and Nvidia Last acquisition: November 21, 2024 Start date: August 24, 2023 All in all, Broadcom had a solid quarter, with continued momentum in its AI semiconductor business partially offset by softness in its infrastructure software. While the company maintained a positive outlook for the quarter, the market was looking for even stronger AI revenue and their share of the aftermarket was declining. Part of this AI stock frenzy had to do with explosive earnings reports and ever-expanding total addressable markets; That's why investors immediately began selling the stock after CEO Hock Tan reiterated expectations for AI semiconductor revenue of $56 billion in fiscal 2026 and backed a target of at least $100 billion in fiscal 2027. But we were encouraged to hear that management expects AI semiconductor revenue growth to continue in fiscal 2028, driven by various six-core initiatives. Customers including Google parent company Alphabet, Anthropic, OpenAI and Meta Platforms. In April, Broadcom signed a long-term agreement with Google to develop and supply multi-generation tensor processing units (TPUs) and AI networks. Also in April, Broadcom struck a deal with Anthropic to deliver an additional 5 gigawatts (GW) of next-generation TPU-based computing starting in 2027. OpenAI and Broadcom reiterated that it has a contractual commitment to deploy 1.3 GW of compute in 2027 as part of a larger deal for 10 GW by 2029. Together with Meta, the company expects to deploy 3 GW of computing capacity by the end of 2028. Helping to ease some concerns about how leading AI frontier labs and soon-to-be publicly traded Anthropic and OpenAI will pay for these chips, Tan announced during the call that he was forming an AI special purpose vehicle (SPV) with Apollo and Blackstone. Two alternative asset managers will provide debt financing to facilitate Broadcom's chip sales. For Broadcom's other two unnamed customers, Tan said he expects shipments to begin in late 2026 and accelerate in 2027. The company received purchase orders totaling $6 billion from these customers. On Broadcom's quarterly earnings call, investors usually get excited when they hear Tan proudly announce that it's added a new AI customer or raised its multi-year AI sales guidance. It's hard for a stock to rebound without something new. AVGO 1Y Mountain Broadcom 1-year return Many of the deals we mentioned were announced in April and Broadcom needs to get some credit from the market. Additionally, the guidance given may seem conservative in hindsight. The company said in its earnings release that it received more than $30 billion in AI semiconductor orders in the quarter, well above the $10.8 billion in revenue it recorded. Judging by the current pace and deals in the pipeline, the company is expected to easily surpass $100 billion in revenue by 2027. But the market wants management to confirm the story rather than leaving it to analyst models. In this environment, ups and downs are necessary, especially for a stock that's up more than 80% in the past year. Another aspect of the call that the market might not like was Tan's admission that rivals could win some designs from Google's proprietary chip and AI program. Although the bond between the two companies remained strong, no one wanted Tan to admit that he might diversify some of Google's resources. In short, the quarter was good but not strong enough to lift the stock after a big move. The sharply negative reaction to solid results is a good example of why taking some profit ahead of the quarter, as we did on Tuesday, can be beneficial. In the long term, Broadcom's AI business will continue to shine and outperform conservative forecasts; Therefore, we are raising our price target to $480 from $425. But given the incredible progress AI trading has made recently, we'll keep the stock's rating at 2. Segment commentary At Semiconductor Solutions, the much larger of the two operating segments and the focus of Wall Street because it houses its artificial intelligence business, revenue growth rose to 78.5%, up from 52.4% a year earlier. Reported revenue of $15 billion beat expectations of $14.7 billion, according to FactSet. AI semiconductor revenue increased 143% year over year to $10.8 billion, accelerating from 106% growth in the prior period. The result was slightly better than the $10.7 billion management had expected. Broadcom's AI business includes both custom chip revenue and networking products such as Ethernet switches that help bring data center together. In fact, the networking segment accounted for nearly 40% of AI semiconductor revenue in the second quarter. Revenue growth in Broadcom's other operating segment, Infrastructure Software, accelerated compared to the previous quarter. But revenue of $7.18 billion fell short of Wall Street expectations of $7.32 billion; This means the segment missed estimates for the second quarter in a row. Guidance Based on estimates compiled by LSEG, Broadcom projects total revenue for its current (third) fiscal quarter to be approximately $29.4 billion, above the expected $28.54 billion. Third-quarter semiconductor revenue is expected to be $20.5 billion, while AI revenue is expected to grow more than 200% year over year to $16 billion, up from $10.8 billion in the reported quarter. But some analysts are modeling AI revenue closer to $17 billion, which helps explain some of the after-hours weakness. Analysts predicted total semiconductor revenue would be $20.1 billion. Infrastructure software revenue is expected to reach $8.9 billion. The company expects fiscal third-quarter adjusted EBITDA to be approximately 68% of projected revenue, or $19.992 billion. The Street's adjusted EBITDA was expected to be $19.392 billion. Adjusted operating income is expected to be roughly 67% of projected revenue, or approximately $19.698 billion. This compares with Street estimates of 67.5% and $19.06 billion. (Jim Cramer's Charitable Trust consists of AVGO, META, and GOOGL. See here for a full list of stocks in the portfolio.) When you subscribe 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 trading alert before buying or selling a stock in his charitable foundation's portfolio. 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