Shareholders of Cypress Semiconductor (CY) have had a great year. The stock has gained double-digits as the company finds new outlets for its products and recently returned to profitability after a multiyear turnaround strategy began to yield results. Even though it's been a good run, it might be time for investors to get greedy with this stock again.
What just happened
The key to understanding the Cypress Semiconductor of 2018 goes back three years, when the old Cypress merged with a rival memory chip maker to consolidate and maximize profitability of its legacy business. A year later, Cypress purchased Broadcom's (NASDAQ: AVGO) connected devices segment, buying its way into a new burgeoning movement to connect billions of consumer goods and equipment to the internet.
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Those acquisitions tripled Cypress' sales, and since then, revenues have continued to grow in the high single digits. Several tailwinds have been at work. The most obvious is growth in connected devices, and the auto industry has been the biggest driver of growth and is now at a third of total revenue. Now a diversified maker of connectivity, microcontroller, and memory chips, the ability to cross-sell various product types to customers has been another catalyst. That has helped profit margins increase as the two acquired businesses get better integrated into operations.
In the first quarter of 2018, revenues were up 9.5% from the year prior. Gross and operating margins increased to 36.5% and 6.1%, respectively, compared to 29.5% and -2.6% in 2017. That led to earnings of $0.02 per share, a small profit, but the first one in years.
Data by YCharts.
What management thinks happens next
Cypress' focus on higher growth end-markets like connected things is just beginning to pay off. Management thinks sales will continue to grow in the high single digits over the long term. However, during the second quarter, revenue is forecast to increase only 2% to 6% over the same period in 2017. That has held the stock back as of late, but the good news is that gross profit should be in line with the first quarter. That means another big year-over-year increase in earnings per share.
With those expected numbers, Cypress' one-year forward price-to-earnings ratio is a mere 12.0. That's pretty cheap for a company with a solid runway for expansion, even if a low bar has been set up for the next quarter. But as long as sales hold the pace they've started off on for 2018, Cypress should easily top $2.5 billion in sales this year -- compared with $2.3 billion in 2017 -- and post its first full-year profit since 2012.
There is, of course, some risk that the stock has exhausted its run higher, chief among them being debt. All of those acquisitions cost money, and at the end of the last quarter, total debt was just under $921 million, while cash and equivalents were only $107 million. That low ratio of cash to debt helps explain the low forward P/E ratio. However, Cypress is using cash flow pay off debt, reducing it by $36 million during the first quarter of the year.
Nevertheless, with the number of connected things continuing to increase, that should enable Cypress to continue on its recovery. With a cheap forward valuation and the business posting strong results, it could be time to get greedy with this stock.
