Reasons of Xilinx´s Bright Future

In this article, let's take a look at Xilinx Inc. (XLNX, Financial), a $11.04 billion market cap company, which is one of the world's leading suppliers of programmable logic chips and related development system software.

PLD and ASICs

We have three types of integrated circuits used in digital devices: processors, memory products and logic devices, which manage the interchange and manipulation of digital signals within a system.

Logic devices can be divided as well into two categories, fixed and programmable. The programmable logic market, or PLD, is led by Xilinx and Altera Corporation (ALTR, Financial). PLD chips have the characteristic that can be programmed, so electronics manufacturers’ instructions can be more easily reprogrammed and can customize their circuitries for specific applications.

This is different from the Fixed logic devices, such as application specific integrated circuits (ASIC), which have fixed functionality and cannot be reconfigured. Since both (fixed and programmable logic devices) can be used in the same devices, there is a natural competition between them. Choosing one or another depends on money. PLDs are more costly on a per-unit basis because they are larger. On the other hand, ASICs are cheaper in high volumes but have also higher up-front startup costs. So, PLDs are used in lower-volume electronics applications, in industries such as: industrial, automotive, military, and wireless and wireline communications.

In the last time, the up-front costs of developing cutting-edge ASICs have risen and this make that PLD has expanded over time. We believe this trend will benefit the firm in the future.

Market share

Both Xilinx and Altera have interesting market share, holding 50% and 39% respectively, according to Gartner. This is good considering that there is a certain loyalty to a company's products because of the familiarity they gain when they start using one product.

Attractive dividends

Xilinx has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. The current dividend yield is 2.7%, which is quite good to protect the purchasing power, especially considering the consistency of track-record dividends payments and favorable expectations regarding dividend growth for the next years. Dividends have been paid since 2004.

Revenues, margins and profitability

Looking at profitability, revenue grew by 5.81% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.62 vs $0.56). During the past fiscal year, the company increased its bottom line. It earned $2.19 versus $1.78 in the previous year. This year, Wall Street expects an improvement in earnings ($2.39 vs $2.19).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

The company has a current ROE of 22.99% which is higher than the one exhibit by Microchip Technology (MCHP, Financial), Analog Devices (ADI, Financial) and Nvidia Corp. (NVDA, Financial).In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Micron Technologies (MU, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 18.5x, trading at a discount compared to an average of 78.5x for the industry. To use another metric, its price-to-book ratio of 3.99x indicates a premium versus the industry average of 1.93x while the price-to-sales ratio of 4.95x is above the industry average of 1.93x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $21.830, which represents a 16.9% compound annual growth rate (CAGR).

Final comment

As outlined in the article, the popularity of PLD is rising because of their flexibility. Further, the per-unit costs are dropping. These two things will benefit Xilinx in the upcoming future. Additionally, it has increased dividends to its shareholders in a regular basis.

The PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Jim Simons (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned