– XLNX stock recovery from March lagging tech and cyclical stocks; we think unjustified

– Huawei, slowing 5G rollout fear has dented sentiment; in our Granny Shots portfolio

– As sales approach pre-COVID-19 levels, stock could rise to old high, up to 40% rise

Xilinx (XLNX), which designs and develops programmable chips, has seen its share price rise about 50% to around $103 in the recent rally from the March lows, as the market broadly discounts a lessening of the COVID-19 spread, and a reopening of global economies. 

If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs
Source: FSInsight.com, Bloomberg

XLNX is basically one of two big players (the other being Intel’s (INTC) Altera unit) in the field of integrated circuits (ICs) in the form of programmable logic devices (PLDs), including programmable System on Chips (SoCs), and other devices. They have end markets ranging from aerospace/defense to communications/data centers to automotive and testing. It’s complicated stuff, requiring a lot of R&D. It’s is a competitive environment, but XLNX is recognized as a leader, having invented field programmable gate arrays (FPGA), ICs designed to be configured by a customer after manufacturing. A standard application specific chip (ASIC), which is cheaper than FPGAs, cannot be programmed. The latter are typically more expensive but also flexible, so a user can change the hardware circuit as needed.

Investors unfamiliar with XLNX might find this interesting: while many other high-quality tech—and even cyclical—companies have surpassed their old highs in this rebound since March, XLNX has not.  For example, both Apple (AAPL) and Microsoft (MSFT) have made new highs and even truck equipment and parts maker Paccar (PCCR) has, too. Not XLNX, whose all-time high was $142 back in April, 2019.

What gives? There are a few issues investors are grappling with (more on this below) but there are also reasons to be cheerful about the stock. As the COVID-19 outbreak continues to ease and economies around the world ramp up, I think XLNX’s results will return to pre-Covid levels faster than Wall Street analysts are expecting. That could lead to the shares approaching the old high in a year or two, a possible 40% rise.

There is a pathway with high probability of returning to peak earnings but the stock has only reflected the broad market’s recovery, says a bullish Paul Latta, principal and portfolio manager at Cedar River Capital, which owns XLNX shares for clients. While not all XLNX end markets are “bulletproof,” other companies with worse outlooks have stocks that have recovered back to highs, he notes.

Additionally, XLNX is in our very own Granny Shots portfolio, which has beaten the market by over 3,490 basis points since inception on January 10, 2019. (See nearby table.)  The San Jose, CA-based tech company is expected to benefit from improving purchase-manager index trends; from growing use of artificial intelligence; and from our expectation of higher inflation in the long term. For more on Granny Shots, click here.

The issues: as with most companies, COVID-19 has dented sentiment, though the company has said the coronavirus hasn’t generally disrupted its business. Nevertheless, car sales were already softening (in China, in particular) pre-COVID-19,  so that end market has suffered.

If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs
Source: FSInsight.com, Bloomberg

Second, the ongoing US-China trade war, with reference to Huawei, has hurt sales. Huawei, reportedly 6%-8% of total XLNX revenue, was placed on the US restricted “entities list” in May, 2019. The UK recently did the same. Last year, XLNX removed Huawei from its forecasts but it is still getting some sales and recently restrictions were eased a bit.

Latta points out that XLNX quarterly EPS has dropped to a run rate of 65-70 cents lately from about 95 cents in 2018-2019 before COVID-19 and the ruckus with Huawei began in May of 2019. Yet, the good news, he adds, is that Nokia (NOK) and Ericcson (ERIXF) are stepping into the breach. Secondly, their products use higher XLNX content than Huawei, which is attempting to source supply in China.  Clearly XLNX will benefit eventually from the continuing rollout of 5G as well as AI, he says.

In the year ended March 28, 2020, XLNX sales rose 3% to $3.2 billion from 2019, when revenues rose 24%. What XLNX terms its advanced products rose 15% in 2020 but core products fell 17%. Europe and Japan were weak, while North America and Asia Pacific grew nicely. Gross margins were 66.9% vs 68.9% EPS $3.11 vs $3.47, respectively.

XLNX expects for the first fiscal quarter ended June 29, to be reported July 30, sales of $720 million to $734 million, up from previous guidance of $660 million to $720 million with gross margins of 67%-68%. The company said it is seeing stronger than expected revenues in its Wired and Wireless Group and Data Center Group, more than offsetting weaker than expected revenues in consumer-oriented end markets, including automotive, broadcast, and consumer.

Robert Sluymer, our head of technical analysis, notes that XLNX crossed above its declining 200-dma in June, and has continued to trend higher above its rising 50-day moving average.  Unlike other peer firms at or near new highs, XLNX appears to be in the early stages of a new bull cycle. He recommends accumulating.  According to Brian Rauscher, our head of global portfolio analysis, XLNX is screening favorably in his single stock ERM model as his proprietary analyst sentiment measure (ASM) for the stock has bottomed and is now rising, which is historically a bullish sign.

XLNX isn’t standing still either. It has said it intends to continue to displace ASICs and traditional PLDs in next generation electronic systems. Latta believes that in the future, programmable chips will likely take share from ASIC. The company has a strong balance sheet with a cash position net of long-term debt of near $1 billion.

Analysts’ consensus is near $4 in EPS in fiscal 2023, which suggests they believe it can get back to peak revenues eventually. If it does, Latta thinks the stock could re-approach its all-time high of $140 in early 2019, when Wall Street last thought $4 EPS was within reach, before COVID-19 and the Huawei issues arose.

Where I could be wrong: The US-China trade war could worsen. XLNX gets most of its chip supply from Taiwan Semiconductor (TSMC).

Bottom Line:  XLNX stock is at a level where the market is not expecting recovery of its end markets. If that happens, as we believe, the stock should rise.

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