Despite Short-Term Headwinds, This Stock Looks Enticing

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A weak macroeconomic environment has kept telecom companies from spending aggressively on infrastructure as investments in the industry take a long time to get accretive. As such, telcos are looking to wait out the current downturn and resume spending when the situation improves.

Slowdown Hits

This slowdown in spending by telecom companies has had a negative effect on equipment makers and component suppliers. Over the past couple of months, we have seen some of the companies who depend on the telecom industry for their bread and butter issue downbeat forecasts. Take Ciena (NASDAQ: CIEN) for example. The company did brilliantly for most of the year and was defying the effects of a macroeconomic slowdown.

But, the spending slowdown finally caught up with Ciena as it missed estimates last quarter and issued a gloomy guidance for the current one. The reason – delayed spending by telecom companies.

One More Down

And just recently, Xilinx (NASDAQ: XLNX), which supplies chips to equipment makers along with other end markets; also fell victim to the macroeconomic slowdown. Xilinx’s second-quarter results were a mixed bag, as the company missed revenue estimates but trumped on earnings. However, the guidance for the current quarter, like Ciena, was a depressing one.

Xilinx expects its revenue to decline in the ongoing quarter, while analysts were calling for a revenue jump. A sluggish economy is a major headwind for Xilinx, leading to lower order backlogs and weakness in end markets. It expects a decline in its communications business, a flat performance from automotive, consumer and broadcast businesses. Xilinx expects that all these factors will lead to a revenue decline of 1% to 5% in the December quarter.

But Certainly Not Out

While the current economic environment is bound to affect Xilinx’s short-term prospects, the company looks well-placed to deliver returns to investors in the long run. Despite facing headwinds, Xilinx is executing its plans methodically. Even though Xilinx projects a revenue decline in the current quarter, it actually expects a year-over-year improvement of almost 210 basis points in its gross margin.

Xilinx states that its 28-nanometer chips are finding great acceptance among customers and the company has recorded a number of design wins for these chips. Sales of 28-nanometer chips exceeded Xilinx’s own targets in the previous quarter, driving sales of its new products higher by 80% from last year. Xilinx possesses the largest family of 28-nm chips in the industry, enabling it to stay ahead of peers. Also, Xilinx is making further additions to this particular product family and plans to launch 20-nanometer chips next month.

Opportunities Ahead

Moreover, Xilinx can expect to benefit in the future as more communication networks are built. The company would benefit as telecom companies build faster networks and data centers for cloud computing are built. For example, AT&T (NYSE: T) is going full-throttle in deploying its 4G network. The company’s LTE service is online in around 70 regional markets and it is looking to double-down on LTE coverage by the end of this year, which means that AT&T is running one year ahead of schedule in 4G deployment.

Thus, as telcos build infrastructure for faster networks in the future, component suppliers such as Xilinx would probably rake in more revenue. Moreover, building data centers for cloud computing would prove to be another tailwind for Xilinx. Xilinx can expect to benefit from Huawei and Cisco (NASDAQ: CSCO), two of its customers, as they expand their cloud computing offerings.

Huawei might be in the news for the wrong reasons nowadays, but the company is nicely positioned to gain from the cloud computing boom in Asia. Similarly, Cisco has been innovating aggressively in the field of cloud computing and it recently updated WebEx and its enterprise collaboration. In addition, being a global leader in networking and communication, Cisco is also poised to benefit from the growing data center infrastructure market which is expected to be worth $152 billion in the next five years.

Thus, the presence of illustrious customers such as Huawei and Cisco along with the roll out of faster networks by telcos is certainly beneficial for Xilinx.

The Takeaway

Xilinx might have issued a downbeat forecast for the current quarter, but the company’s innovation, well-known customers and opportunities from cloud computing and communication networks should act as tailwinds in the long-term. In addition, Xilinx returns cash to shareholders through a decent dividend yield of 2.7% and share repurchases. The stock’s year to date performance is not quite great with a 6% return, and short-term prospects are clouded by uncertainty. But Xilinx certainly has the ingredients to deliver value over the long run.

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