There is a great deal of excitement surrounding 5G, and rightly so. Mobile network providers are rolling out the first iterations of the new service, and the number of smartphones offering connectivity is ramping up.
Meanwhile, it's the back-end construction of the 5G network itself -- rather than the consumer-facing service -- that holds some of the most promising investments in the new mobility movement. A massive number of hardware and software management tools will be needed to expand coverage and improve the reliability of 5G. Three stocks that play in that sandbox that I think are buys right now are Xilinx (XLNX), Skyworks Solutions (SWKS -1.03%), and Ciena (CIEN -1.76%).
Multi-purpose chips for a multi-use network
Xilinx is the leading designer of field programmable gate arrays (FPGAs), chips that can be reprogrammed post-manufacture and thus are suitable for use in a wide range of applications. As the initial buzz surrounding 5G started a few years ago, Xilinx sales (and share price) skyrocketed as the flexible semiconductors were in high demand.
Then the U.S.-China trade war started, culminating in the blacklisting of Chinese tech titan Huawei in the spring of 2019. The lost revenue from Huawei, as well as a general chip industry demand slump, eventually pushed Xilinx into year-over-year contraction. As of this writing, the stock is down nearly 30% from all-time highs reached in early 2019.
In spite of new challenges this year presented by the COVID-19 pandemic, signs of a rally for FPGAs are shaping up. Data center construction remains an area of strength as cloud computing continues to proliferate, and Xilinx also said it was awarded a design win on Samsung's second-generation 5G radio unit (the boxes that create 5G network signals). And more recently, the resumption of sales to Huawei led to an updated and upgraded outlook for the spring 2020 quarter. The numbers are still expected to be down from a year ago, but Xilinx is getting close to being back in growth mode once again.
The semiconductor industry is a cyclical one, with periods of booming revenue followed by droughts. But the best time to buy shares of chip stocks is when they are starting to climb out of a sales trough. It would appear Xilinx is in the early stages of a new run higher. The stock trades for 23.8 times trailing 12-month free cash flow (revenue less cash operating and capital expenses) -- not exactly cheap, but a reasonable price tag as the company starts to lap its downturn and returns to profitable expansion.
A new type of radio signal needed
Skyworks Solutions has also been stuck in a rut for a few years. The company rode the coattails of the smartphone boom, providing Apple (AAPL -1.00%) with network connection-enabling chips for the iPhone. Skyworks is still heavily reliant on the smartphone market (not exactly a great place to be at the moment, as researcher IDC expects smartphone sales to drop 12% in 2020), but it has used its bread-and-butter chips as a springboard into diversifying its offerings, and now provides connectivity semiconductors for other consumer electronics and industrial equipment.
Thus, with the economy down in the dumps right now, it might seem surprising that Skyworks' stock has suddenly gotten a second wind. After years of sideways up-and-down movement, shares have pushed to new all-time highs in 2020. The reason? Optimism surrounding new 5G sales.
While smartphones aren't high on the purchase priority list right now, demand is expected to rebound sharply later this year and into 2021. Many of those new phones will need to be equipped with 5G connection-enabling chip sets, which plays into Skyworks' favor. The company also designs systems and hardware for the many other devices that will eventually be hooked up to 5G in the coming years, from vehicles to manufacturing equipment to medical devices. With a market cap of $22 billion, this is still a relatively small company that could pick up lots of new mobility market share in the not-so-distant future.
Much like Xilinx, Skyworks is still trying to pull itself out of a slump after trade war difficulties, but 5G holds the answer to the problem. Trading for 23.9 times trailing free cash flow, it too isn't particularly cheap. Nevertheless, this company has zero debt and $1.11 billion in cash on the books. As 5G continues to spread, shares look like a good long-term value right now.
Firming up the back-end of the network
Speaking of small companies, Ciena is by far the smallest company on this list, with a market cap of just $8.6 billion. However, it's well on its way to getting a lot bigger. Shares are up over 20% since I called Ciena a best of 2020 5G stock a few months ago, and its run may be far from over.
Ciena provides fiber optic equipment and software management tools for network operators. As 5G is a wireless tech, what does Ciena have to do with it? While 5G is mobile for the consumer, network operators need to build out physical infrastructure to support the high-speed 5G radio signals that get delivered to customers. That means fiber optic line and network switches, as well as modern and more flexible software-defined networking management. As mobility has grown, Ciena has also slowly but steadily grown over the years. But new 5G standards could provide a big bump higher.
Along the way, the company's software platform has taken off and boosted profit margins. That is leading to some dramatic upside for the bottom line. For example, during the company's fiscal 2020 second quarter, revenue increased just 3.4%, but adjusted earnings per share soared 58%. As the internet goes increasingly mobile, demand for Ciena's fiber optic products and software-defined networking toolkit should keep profitability headed north.
Given the fast-developing profitable scale at Ciena, a price-to-free cash flow ratio of 23.0 seems like quite the value. With the world adjusting to higher internet reliance and the need for more data to be processed via the web, this small modern-day infrastructure company is near the top of my buy list.