Should You Chase Xilinx's Post-Earnings Rally?

Shares of Xilinx (XLNX) surged 18% on Jan. 24 after the chipmaker's third-quarter earnings beat analysts' estimates. Its revenue rose 34% annually to $800 million, beating expectations by $30 million. Its non-GAAP net income rose 42% to $237 million, or $0.92 per share, which topped estimates by seven cents. On a sequential basis, Xilinx's revenue and net income both rose 7%.

Xilinx expects to generate $815-$835 million in revenues in the fourth quarter, which represents 21%-24% annual growth and 2%-4% sequential growth. That's much higher than the consensus forecast of $776 million, and indicates that Xilinx is bucking the slowdown across the semiconductor market.

Image source: Getty Images.

Analysts expect Xilinx's revenue to rise 20% for the full year, but that forecast will likely be revised to reflect Xilinx's rosier guidance. Xilinx didn't provide any earnings guidance, but analysts expect its earnings to rise 31% annually for the fourth quarter and 63% for the full year.

Analysts expect Xilinx's revenue and earnings to rise 7% and 9%, respectively, next year. However, Xilinx didn't provide any forecasts for fiscal 2020, and said that it would offer clearer estimates during its Investor and Analyst Day on May 14. Let's dig deeper into Xilinx's third quarter numbers to see if investors should chase this post-earnings pop.

Breaking down the main numbers

Xilinx mainly sells FPGAs (field-programmable gate arrays), a class of programmable chips that can be customized for a wide range of industries. Xilinx invented FPGAs three decades ago, maintained that first-mover's advantage, and consistently held a larger market share than its closest rival, Altera -- which Intel (INTC 1.77%) acquired in 2015.

Xilinx also remains ahead of Intel on the tech curve. Its latest FPGAs are 7-nanometer chips, while Intel is still making a painful transition from 14-nm to 10-nm chips. That's why Altera, now known as Intel's PSG (Programmable Solutions Group), grew its revenues by just 8% annually last quarter.

Xilinx generates its revenue from five main markets: Data Center and TME (Test, Measurement, and Emulation) customers; Auto, Broadcast, and Consumer customers; Communications customers; and Industrial, Aerospace, and Defense customers. Here's how those four businesses fared during the third quarter:

Source: Xilinx Q3 report.

Xilinx attributed the strong growth of its Communication division to the production of 5G hardware, pre-5G deployments, and LTE upgrades, especially in South Korea and China. Its Aerospace and Defense revenues were bolstered by "broad strength" across multiple defense programs.

Xilinx admitted that plummeting demand for cryptocurrency mining solutions dented its data center growth, but that the unit's "core" revenues (excluding crypto) "nearly doubled" year-over-year. Demand for its automotive chips was also buoyed by higher sales of ADAS (advanced driver-assistance systems) and autonomous driving solutions.

Image source: Getty Images.

Looking ahead, Xilinx expects rising demand for AI and machine learning solutions to bolster demand for its FPGAs in the data center and automotive markets. That's why it acquired Chinese machine learning start-up DeePhi Tech last year.

Xilinx expects its fourth quarter growth to be driven by the strength of the Communications and Data Center/TME markets again, which should only be partly offset by declines in its Automotive, Broadcast, and Consumer markets.

But mind the margins and valuation...

Xilinx's top line growth looks healthy, but its margins are declining. It reported a gross margin of 69% during the third quarter, roughly unchanged from the second quarter but a 130 basis point drop from a year earlier. That decline is expected to continue, with its gross margin dropping to 68.5% in the fourth quarter. Additional pressures from tariff impacts, which Xilinx calls "speculative" at this point, could exacerbate the decline.

On the bright side, Xilinx's non-GAAP operating margin of 32.9% marked a 130 basis point improvement from the second quarter and a 590 basis point gain from a year earlier. Xilinx expects its operating expenses to rise less than 4% sequentially during the fourth quarter.

Xilinx's well-diversified business model, which places irons in the fire across many promising industries, makes it a safer play than chipmakers that are concentrated in a smaller number of markets (like PCs and phones) or large customers. However, the stock also trades at over 30 times next year's earnings, indicating that a lot of that optimism is already baked in. I still like Xilinx as a long-term investment, but I think investors should wait for a pullback instead of chasing this post-earnings rally.

Check out the latest Xilinx earnings call transcript.