Broadcom (AVGO) Fiscal Q4 Preview & Stock Alternative

by riskreversal December 8, 2016 1:23 pm • Trade Ideas

Event: Broadcom (AVGO) reports their fiscal Q4 results tonight after the close. The options market is implying about a 5.5% one day post earnings move tomorrow, which is essentially in line with the average over the last 4 quarters. With the stock at $170, the Dec 9th (tomo expiration) $170 straddle (the call premium + the put premium) is offered at $9.50, if you bought that and thus the implied movement, you would need a rally above $179.50, or a sell-off below $160.50 to make money.

Price Action / Technicals: Despite out-performing the broad market, up 16% ytd, AVGO has massively under-performed the Philadelphia Semiconductor Index (SOX) which is up 35% year to date.

Since early August AVGO has traded in a fairly well defined range between $160 and $180, making the implied move fairly logical:

[caption id="attachment_68760" align="aligncenter" width="600"]AVGO 1yr chart from Bloomberg AVGO 1yr chart from Bloomberg[/caption]

Sentiment: Wall Street analysts are almost universally bullish on AVGO with 30 Buy Ratings, only 2 Holds and NO Sells with an average 12 month price target of about $206, or 20% above current levels.

Estimates & Forecasts from Bloomberg:

-4Q adj. EPS est. $3.36 (range $2.92-$3.47)
-4Q rev. est. $4.12b (range $4.08b-$4.18b), co. forecast $4.1b-$4.18b on Nov. 2
-4Q gross margin est. 60.5% (range 60.3%-60.6%), co. forecast 59.5%-61.5%
-1Q rev. est. $3.97b
-1Q gross margin est. 60.5%

Expectations: In a note to clients yesterday, JPM semi team expects:

the company to report revenue in line to slightly better than the positively revised guidance ($4.1 billion to $4.175 billion, or about $4.14 billion at midpoint) and expectations (about $4.12 billion), driven by seasonal increases in wireless and storage, along with sustained strength in data center and optical, while offset slightly by seasonal weakness (and supply constraints) in set-top box systems on chips (SOCs).

We anticipate in-line to slightly better earnings per share as well, driven by operating-expenditure cuts/synergy savings (guide was flattish quarter-over-quarter) and overall solid execution. In addition, we expect some updates to the company’s capital-return strategy (dividends). For the January quarter, we expect in-line guidance (consensus at down about 3% quarter-over-quarter), driven largely by the seasonal decrease in wireless (down low-double-digit percentage quarter-over-quarter), flat to slight growth in storage, and flattish wired.

We anticipate product-cycle strength to continue in data center (Tomahawk, Jericho, and Qumran to customers such as Cisco Systems (CSCO), Arista Networks (ANET), HP (HPQ), Dell and white box vendors) and optical (100G build-outs). We anticipate operating-expenditure outlook to come in better than expected, driven by the exit of the multi-core ARM processor and other embedded processor projects.

BRCM is a cheap stock, trading 12.6x expected 2017 eps growth of 19%, on 22% expected sales growth with expected gross margins nearing all time highs just below 61%.

A beat and raise and I suspect the stock is re-testing the prior highs. In line qtr and guidance and the stock under-performs the implied move up or down, likely up or down a couple percent. Miss and guide down and the stock is likely through $160 support, (also the 200 day moving average, which it has not been below since February), on its way to $150.

There is some concern about AVGO’s exposure to the difficulties that Samsung is facing since their Galaxy Note 7 exploding battery issues but this is a pretty diversified company following the merger, with Apple and Samsung as large clients in mobile but also datacenter/enterprise and other core businesses:

We believe Avago Technologies’ [predecessor company] wireless exposure was more concentrated in high-end handsets at global OEMs (Apple, Samsung [of South Korea]) and less in China handsets pre-merger driven by capacity constraint issues and lower penetration of FBAR filter technology in China overall, while Broadcom’s [predecessor company] connectivity business was more diversified, in our view, with opportunities/traction at China smartphone makers in addition to embedded connectivity sales.

We estimate the company’s wireless exposure stays around the 35% range post-merger, but Apple exposure declines from about 20%-24% pre-merger to about 15%-16% post-merger, and the concentration will likely go down further as the company expands capacity to serve China local handsets and multi-band/carrier aggregation drive further adoption of FBAR filters in the country. Meanwhile, the merger with Broadcom brings to the table strong exposure to datacenter/enterprise (about 20% post-merger) and broadband (about 15%-18% post-merger) which together with a strong wired infrastructure franchise should provide the company with several growth drivers in 2016 and beyond.

So What’s The Trade? [private]

The implied move has the stock going just short of 180 resistance on the upside or 160 support on the downside. Those long the stock, and looking for protection should protect against a breakdown below 160 because there is little support below that. Those long the stock or looking to be long should to that 180 level for targeting.


Bullish: Stock Alternative

AVGO ($170.50) Buy the Dec 9th (tomo) 170/182.50/195 call fly for $3.50
  • Buy 1 Dec9th 170 call for 4.70
  • Sell 2 Dec9th 182.50 calls at 65 cents (1.30 total)
  • Buy 1 Dec9th 195 call for 10

Break-Even on Tomorrow’s Close:

Profits: between 173.50 and 191.50 of up to 9.50 with max gain of 9.50 at 182.50

Losses: up to 3.50 between 170 and 173.50 and between 191.50 and 195 with max loss of 3.50 below 170 and above 195.

Rationale – This limits overall risk to $3.50 (vs an implied move of $9.50) and targets a few bucks above the implied move on the upside. With options prices elevated into the event, this trade structure looks to mitigate some of the post event vol crush tomorrow.

But we will offer our usual disclaimer for long premium directional trades into events, you need to get a lot of things right to just break-even, direction, magnitude of the move and timing.