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Why Xilinx Stock Is Set to Fly Higher

By Harsh Chauhan - Nov 12, 2018 at 8:47PM

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This chipmaker is taking advantage of several fast-growing markets.

The broader semiconductor market is in shambles right now, but that didn't stop Xilinx (XLNX) from reporting terrific fiscal second-quarter results that crushed Wall Street estimates by a mile. The results convinced investors that the programmable chip specialist is riding on solid catalysts strong enough to help it navigate the short-term hiccups in the semiconductor industry.

This point was driven home by Xilinx's third-quarter outlook, which calls for a 22% annual jump in the company's top line, to $770 million. For comparison, Wall Street was expecting guidance of just $720 million.

The fact that Xilinx has now stepped on the gas doesn't seem entirely surprising. The company has been pulling the right strings to corner a bigger share of the massive artificial intelligence (AI) opportunity, and it won't be stopping anytime soon. Here's why.

Artist's rendering of a processor on an integrated circuit.

Image Source: Getty Images.

Two important catalysts

Xilinx's communications and data center businesses showed remarkable growth last quarter. Its communications revenue shot up 33% annually thanks to the beginning of fifth-generation (5G) wireless technology deployments. Xilinx pointed out on the latest earnings conference call that it has moved from the prototyping phase to the early production phase of 5G-centric chips.

Xilinx started introducing 5G chip platforms over a year ago in a bid to stay on top of this emerging technology trend. The company integrated 5G functionality into its Zynq UltraScale+ MPSoC chip family in October of last year, making samples available to customers as part of an early access program. Now Xilinx's early move into this market is paying off, as it seems to be converting those early access customers into actual clients.

More importantly, Xilinx is now in a solid position to take advantage of the impending 5G boom, with some estimates putting the number of 5G connections at more than 1 billion by 2023. That would create the need for more 5G infrastructure and push up demand for Xilinx's programmable chips aimed at this market.

Meanwhile, the company's data center business  is also displaying remarkable growth. Revenue from this segment was up 28% year over year in the latest quarter, making it Xilinx's second-fastest-growing business. The chipmaker attributes this rapid growth to the increasing adoption of its field-programmable gate arrays (FPGAs) across various data center verticals such as storage and computing.

Samsung Electronics, for instance, is using Xilinx's programmable chips in its smart solid-state drive (SSD) product for boosting computing speeds in the data center. This paves the way for Xilinx to take advantage of yet another fast-growing space. SSDs are expected to take over data center storage going forward, as they occupy less real estate and are faster than traditional storage drives. That's how they bring down the operating costs of a data center.

On the other hand, major cloud service providers continue to deploy Xilinx's programmable chips in their data centers to accelerate workloads. Amazon.com and Alibaba Group Holding were the early adopters of Xilinx's FPGAs in the data center, and they are now expanding the availability of those FPGA-powered servers across more regions.

Amazon, for instance, has doubled the deployment of Xilinx's FPGA-powered cloud computing servers from four zones to eight. In China, Alibaba and Huawei have already announced the general availability of cloud servers based on Xilinx's programmable chips. What's more, the company is now looking to push the envelope further in data centers with a new range of accelerator cards that'll boost performance across several AI applications.

The best part is that Xilinx's data center momentum is just getting started; deployment of FPGAs will only get better, as they are better at handling certain AI tasks than other chips. This is one of the reasons FPGA sales are expected to exceed $12 billion by 2024, compared to less than $7 billion in 2016.

Now that Xilinx commands around 60% of the FPGA market and is looking to steal a march on its nearest rival with a new product platform, it is in pole position to tap into this opportunity.

More reasons to buy

The catalysts discussed above are just some of the reasons investors should consider going long Xilinx. A closer look at the company reveals a few more reasons this chipmaker could turn out to be a solid long-term bet.

For instance, Xilinx has a respectable dividend yield (1.7%) when compared to the overall tech sector's average, and it has the potential to raise its dividend now that its growth has picked up pace. The jump in the company's top and bottom lines last quarter led to a strong increase in free cash flow.

XLNX Free Cash Flow (TTM) Chart

XLNX Free Cash Flow (TTM) data by YCharts

Looking ahead, Xilinx's free cash flow profile should keep getting better, as the catalysts discussed above will lead to a stronger bottom line. Analysts estimates compiled by Yahoo! Finance are that earnings will increase at an annual pace of more than 17% over the next five years, which is way better than the 4% annual earnings growth it has clocked over the last five.

This paves the way for stronger dividend growth. So Xilinx investors will not only benefit from the growth of emerging tech trends such as artificial intelligence and 5G, but also stand to gain from a potential increase in the dividend. This makes Xilinx a solid semiconductor bet given that it trades  at 22 times next year's earnings, as it is only slightly more expensive than the industry average price-to-earnings ratio of just over 19.

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