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Is It Finally Time to Buy Cypress Semiconductor?

By Leo Sun - Oct 29, 2018 at 10:29AM

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This little chipmaker is becoming too cheap to ignore.

Shares of Cypress Semiconductor (CY) tumbled nearly 30% over the past three months as concerns about trade tensions, peaking memory chip prices, high inventory levels, and declining prices gutted the semiconductor sector. Lackluster guidance from industry bellwethers like Texas Instruments exacerbated the pain.

Despite those headwinds, Cypress still easily beat analysts' expectations with its third quarter earnings report on Oct. 25. The chipmaker's revenue rose 11% year over year to $673 million, surpassing estimates by nearly $3 million and marking an acceleration from the 5% growth it achieved in the second quarter. Cypress' non-GAAP net income rose 54% to $153 million, or $0.40 per share, which also beat estimates by two cents.

A chip on a circuit board.

Image source: Getty Images.

But looking ahead, Cypress anticipates a 2% year-over-year decline to 3% revenue growth in the fourth quarter, which falls short of the consensus forecast for 8% top-line expansion. The company attributes the slowdown to some "softness" in line with its industry peers, but notes that it will still deliver 7% sales growth for the full year. On the bottom line, Cypress expects its non-GAAP earnings per share (EPS) to rise 11 percentage points to 25% year over year, which meets the consensus forecast for 25% growth.

Do Cypress' earnings indicate that this struggling stock has finally bottomed? Let's dig deeper into the report to find out.

Breaking down the core numbers

Cypress' MCD (Microcontroller and Connectivity Division) revenue rose 11% year over year during the quarter and comprised 61% of the company's top line. Revenue at the MPD (Memory Products Division), which accounted for the rest, rose 12%.

Looking at Cypress' top line through the lens of end markets, automotive and industrial revenue together contributed 50.6% of company revenue during the quarter, compared to 48.3% in the prior year. That growth reduced Cyrpress' dependence on the consumer and enterprise markets, which together generated the remaining 49.4% of total revenue.

Cypress' non-GAAP gross margin arose 4 percentage points year over year to 47% as its operating margin on the same basis jumped 5.7 percentage points to 22.3%. Both figures also expanded significantly on a GAAP basis. For the fourth quarter, Cypress anticipates a non-GAAP gross margin of 47% to 48%, up from 45.4% a year earlier.

Cypress attributes ongoing margin expansion to the execution of its "Cypress 3.0" strategy, which repositioned the chipmaker in 2017 as a provider of bundled chip solutions for the automotive, industrial, and consumer IoT (Internet of Things) markets. The organization aims to keep its operating margin above 20% by optimizing its supply chain to deal with industry cycles and macro challenges.

Network connections across a smart city.

Image source: Getty Images.

A smart joint venture

One such strategy is a new joint venture with SK Hynix (NASDAQOTH: HXSCL), which will manufacture and sell Cypress' SLC (single-level cell) NAND memory products and invest in next-gen NAND products. Cypress will own a 40% stake in the JV, while SK Hynix will control 60%.

Management expects the deal to close by the first quarter of 2019. During the company's third-quarter conference call, CEO Hassane El-Khoury noted that while the JV "will negatively impact our near-term EPS, it will be accretive to Cypress' revenue growth, gross margin and cash flow in the long run."

El-Khoury also relayed that Cypress' remaining portfolio of NOR and SRAM solutions will focus on "more predictable markets" with a long-term gross margin target of 50%. In other words, Cypress is handing off its cyclical NAND business, which is often cited as its Achilles' heel, to the JV, to protect its margins and free up resources for the development of niche memory solutions like NOR and SRAM chips.

Cypress expects the deal to significantly reduce the MPD unit's dependence on the consumer electronics market, and foresees that most of the segment's future growth will come from the higher-growth ADAS (advanced driver assistance system), industrial IoT, and 4.5/5G markets.

This move could also offset some of the pressure from rising tariffs. El-Khoury admitted that the tariffs were causing some "disruptions", especially in Asia, but stated that Cypress remained "extremely well-positioned for the next wave of growth from IoT applications."

A low valuation and a high dividend

I personally think Cypress is still one of the best plays on the automotive and industrial IoT markets, and that its growth remains on track despite the recent speed bumps. At $12, the stock trades at just 9 times this year's earnings, and it pays a forward dividend yield of 3.6%.

Cypress' low enterprise value of $5.5 billion also makes it an attractive takeover target for bigger chipmakers like Texas Instruments, which also focuses heavily on the automotive and industrial markets. Therefore, I believe that the potential rewards clearly outweigh the short-term risks for this beaten-down stock.

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