AVGO is a leading designer, developer, and global supplier of a broad range of analog semiconductor devices, with a focus on radio frequency, or RF. Our Strong Buy recommendation reflects our views about valuation and attractive growth prospects over the next 12 months.
We expect AVGO to benefit from favorable trends in the data center space as well as a new iPhone cycle in the second half of the calendar year.
We also think robust free cash flow generation will allow AVGO to significantly return cash to shareholders. We see upside in AVGO given our view of attractive valuation and potential earnings/free cash flow leverage.
We are encouraged by AVGO's increasing shift to its higher-margin infrastructure software business, which is more recurring and offers diversity from semiconductors. AVGO will likely benefit from improving networking demand for its switching and routing platforms as well as for its custom ASIC solutions in cloud, in our view.
We have high confidence in management execution and expect AVGO to benefit from higher spending from cloud customers and telecom providers that are looking to upgrade their infrastructure and networks. We think end-market visibility remains extremely high through the rest of the calendar year across all core end markets.
AVGO is benefiting from elevated broadband and network growth, while wireless (up 48% in the Apr-Q and 34% of semiconductor revenue) sees easy comparisons from 5G content gains related to FBAR and WiFi.
We think smartphone replacement cycles have stabilized in 2021 after extending for the last four years, while the company has also been benefiting from content gains as customers shift to 5G devices.
We think content gains for 5G devices are 30% to 40% higher than 4G phones as it pertains to AVGO's offerings. Infrastructure Software revenue is very predictable, with over 90% of bookings recurring and average contract term length at three years.
We believe AVGO's broadband business is going through a resurgence (18% of semiconductor sales), as the work, learn, and play from home environment is driving global service providers to expand connectivity to the home.
On the broadband carrier access side, AVGO's passive optical network (PON) business will see significant content growth as 10G PON deploys over the next few years and cable operators in the U.S. drive deployment of DOCSIS 3.1 cable modems, with plans to accelerate the upgrade to nextgeneration DOCSIS 4.0. In networking (up 10% in the Apr-Q and 32% of semiconductor revenue), we see tailwinds from hyper cloud and telecom customers.
Revenue for switching is witnessing a strong ramp for AVGO's Trident and Tomahawk 3 offerings for over 400G platforms and from hyper cloud data centers. In the network, service providers have been investing in 5G infrastructure worldwide and we expect enterprise demand in networking to recover in the coming quarter.
We like free cash flow potential (52% of Apr-Q sales), which we see at $12.5 billion in FY 21 and $13.1 billion in FY 22 (vs. $11.6 billion in FY 20). We expect excess cash to support dividend hikes (we project a 10% to 15% boost in December) and a potential return to acquisitions.
Our 12-month target price of $510 is based on a P/E of 17.5x our FY 22 EPS estimate of $29.12, above AVGO's five-year historical forward average of 13.3x but below chip peers to reflect its more leveraged balance sheet.
We view AVGO's 3% plus yield as among the most attractive and sustainable within the semiconductor industry. Risks to our recommendation and target price include, greaterthan- projected pricing pressure and more competitive pressures.