People are contemplating 5G in terms of what it can afford in the future: virtual and augmented reality, automated factories and farms, and perhaps a substitute for broadband. New applications are also likely to be invented when 5G capability is fully implemented.
But what actions will benefit most from 5G? It may not be the phone companies or operators, but the major semiconductor companies that are fueling this new platform. This is because 5G requires more radios, data centers, and fiber links getting closer to customers, in addition to more advanced smartphones.
Therefore, not only will more chips be needed, but 5G will also need more specialized, high-margin chips to manage all this speed and data traffic efficiently.
With the 5G ecosystem that touches so many devices, from phones to radios to data center servers, semiconductor companies with wide exposure, such as Broadcom (NASDAQ: AVGO) i Lam Research (NASDAQ: LRCX), are likely to benefit greatly in the 5G era. What is even better? Both stocks are paying rising dividends, so investors are being paid to expect more 5G-driven growth.
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Broadcom: One of the Cheapest 5G Stocks
Last week, Broadcom reported its third-quarter tax benefits. Revenue rose a solid 16%, to $ 6.788 billion, and adjusted earnings per share (non-GAAP) of $ 6.96 rose 28.9%. Both figures exceeded analysts’ expectations.
Broadcom has a remarkable growth-acquisition strategy, conceived by visionary CEO Hock Tan. Broadcom often targets software companies with profitable chips or programs and competitive advantages, uses debt to buy them, and then makes more profits by reducing overhead costs. As a result of this strategy, Broadcom now has a very diverse portfolio of chips going to phones, data centers and general communications equipment, which are used in 5G.
Last quarter’s results showed that Tan’s strategy worked like a charm: gross margin rose 85 basis points to 75%, even though overall operating expenses were flat year after year. The result is a drop in cash, with Broadcom minting $ 3.43 billion in free cash flows in revenue of just $ 6.788 billion, good for a free cash flow margin of more than 50%.
Broadcom pays a dividend of 2.9% at the current share price and this payment is likely to increase again soon. Broadcom’s strategy is to return half of the free cash flow as dividends, with the other 50% set aside for acquisitions, amortization or debt amortization.
Broadcom’s cash on the balance sheet also rose to $ 11 billion and $ 40 billion in debt, and cash is expected to grow to $ 13 billion by the end of this quarter. Given his highly profitable business, Tan said in the conference call with analysts that this level of cash is between $ 6 billion and $ 8 billion above where he would like it. This means that if the company does not make an acquisition soon, it could set up a share repurchase program in addition to its dividend. Any of these scenarios would be great news for shareholders.
Despite solid growth and more effective than it needs, Broadcom shares are trading at just 16.5 times next year’s earnings forecasts, below the global market multiple. It seems too cheap for a company exposed to many technology megatrends, including 5G.
LRCX Total (daily) 6-month return data for YCharts
Lam Research: making the best tabs in the world
Like Broadcom, semiconductor equipment supplier Lam Research has been relatively quiet over the past six months, meaning it could be a good time to pick up stocks. In fact, in a relatively quiet August for the company, Lam quietly announced a 15% increase in its quarterly dividend to $ 1.50 per share. This represents a 400% increase in the dividend in the last five years.
The reason Lam has done so well, and should continue to do so well at the age of 5G, is its advantage in engraving and deposition machines, which are critical to producing the most advanced logic chips and chips. NAND flash more densely stacked. 5G usually requires cutting-edge chips in smartphones, radios, and high-end data centers, so Lam’s computers should be in high demand whenever that’s the case.
Lam also earns a larger share of the normal income from its service segment, which accounted for a third of last quarter’s revenue. Services generally grow with the base installed each year, even as equipment sales may be uneven. But equipment sales are also booming, 48% more than last quarter.
In response to the well-documented chip shortage, the world’s largest foundries have announced large multi-year spending plans to meet demand and remain competitive. Last month, key customer Samsung announced a major increase in its spending plans over the next three years. This means that Lam will have great visibility into the growth of equipment sales for at least the next two years.
Stocks of semiconductor equipment increased in late 2020 and early 2021, but after such a hot start to the year, Lam shares have been tracking the market for the past six months. I would like to do this until the mere profit and a healthy consolidation before the next stage. Lam is trading at just 22 times subsequent profits and 17 times next year’s earnings estimates, which seems too cheap for a stock that will benefit over the duration of the 5G era.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool advisory service. We are motley! Questioning an investment thesis (even one’s own) helps us reflect critically on investment and make decisions that help us be smarter, happier, and richer.