'Use the dip to buy': why Melius expects drawdown after Broadcom report

Melius analysts predicted a decline in shares of chip developer Broadcom after its reporting due to the inflated expectations of market participants - as it happened with Nvidia. At the same time, they raised their target price on Broadcom's shares and reiterated a buy recommendation. Broadcom remains a must-own AI stock, Melius says, and he intends to take advantage of any drawdown to buy.

Analysts at Melius, led by Ben Ritzes, raised their two-year target on Broadcom shares from $305 to $335 and maintained a "buy" recommendation ahead of the quarterly report, which will be released on September 4. This was reported by MarketWatch. The new target price Melius suggests that the company's quotes could grow by more than 12% from the closing level of trading on September 2.

Ritzes believes that Broadcom will have a hard time meeting the market's high expectations from players in the AI sector: the company has already pledged to grow AI revenue by 60% next year, and it's unlikely to raise that bar higher. Nvidia and Marvell Technology reports have already shown the same, after which their shares fell despite good results, MarketWatch notes. Melius suggested that Broadcom could see a similar reaction.

However, Broadcom is "operating at full capacity," Melius analysts note, and so they are willing to "use any dip to buy, as there are almost no companies of this caliber in AI outside of Nvidia."

Broadcom is "in a unique position" next to global AI processor market leader Nvidia, according to Melius. While Nvidia can achieve a long-term growth rate in the data center segment of 50% per year, Broadcom forecasts AI revenue growth of 60%: it could exceed $5.1 billion in the last quarter and $30 billion next year, the analysts wrote.

Broadcom is among the "must-have" AI stocks to own, Melius argues: the company has a leading position as a fabless chip designer (designs but doesn't manufacture them), and its strong networking segment, which generates 33% of revenue, is getting a boost from growing demand for AI gas pedals (XPUs) and network processors from hyperscalers (operators of the largest cloud services).

The Melius analyst acknowledged that Broadcom's stock looks expensive on a price-to-earnings (P/E) basis right now, but stressed that for that price, investors are actually getting a stake in three areas at once: leading chip-building programs, advanced networking solutions for data centers, and reliable software, the revenue from which does not depend on the number of users, which could decline due to AI.

Broadcom's biggest customers include Google and Meta and China's ByteDance, which are ramping up spending on AI chips, Melius noted. And in the future, the ranks of Broadcom's customers could be joined by ChatGPT owner OpenAI, Elon Musk's companies, as well as Arm Holdings, Apple and another major hyperscaler: this would ensure revenue growth even beyond 2027, analysts said.

In addition, Broadcom's business is boosted by VMware, which it bought in November 2023: its cloud and subscription services are generating steady revenue.

Broadcom could be the next driver of the entire AI chip sector after Thursday's earnings release, Barron's notes. Investors will be keeping a close eye not only on demand forecasts, but also on signs of whether the company's custom AI chips have begun to take share away from market leader Nvidia, the publication adds.

Most analysts covering the company's stock have reiterated their forecasts over the past 30 days, Yahoo Finance reports. Broadcom has fallen short of Wall Street's revenue forecasts just twice in the past two years, the portal adds.

Wall Street's consensus forecast calls for Broadcom to report earnings of $1.66 per share, up from $1.24 in the same quarter last year, TipRanks reports. The company's revenue will grow about 21% year-over-year to $15.83 billion, with the semiconductor solutions segment expected to account for $9.1 billion in revenue, MarketWatch adds.

In trading on September 3, Broadcom shares jumped 2% to $304.4, and since the beginning of the year they are up 30%. For comparison, the main U.S. stock index S&P 500 for the same period added about 9.3%.

More than 90% of analysts are advising investors to buy Broadcom stock (Buy and Overweight estimates), and the Wall Street consensus target price ($309.5) suggests it's up another nearly 4% from the last close.

This article was AI-translated and verified by a human editor