Synaptics (NASDAQ:SYNA) has been down in the dumps for a very long time now. Not much has clicked for the chipmaker, as stiff competition in the semiconductor space and stagnating smartphone sales have acted as headwinds and hurt its top and bottom lines.

Synaptics turned that narrative on its head, however, with a solid first-quarter report on Nov. 9. The results are an indication that its bet on an emerging tech trend -- the Internet of Things (IoT) -- is paying off. Additionally, its strategy of focusing on a fast-growing smartphone niche is helping another part of its business make a comeback.

Investors liked what they saw, as the stock has finally pulled up from its 52-week lows -- and it won't be surprising to see it deliver more upside. Let's examine why.

Icons in a honeycomb pattern that represent the internet of things.

Image Source: Getty Images.

What's working for Synaptics?

Synaptics finally reversed a long trend of declining top and bottom lines in the first quarter of its 2019 fiscal year. The company's revenue was flat year over year, while non-GAAP net income increased 27% annually to $44.6 million. Notably, Synaptics posted a GAAP profit of $3.8 million during the quarter as compared to a $26.5 million loss in the prior-year period.

What's more, the company's key financial metrics -- revenue, gross margin, and earnings per share (EPS) -- were close to the higher end of its own guidance range. The margins deserve a special mention here as well because Synaptics has recorded five consecutive quarters of gross margin growth. The metric increased 280 basis points annually last quarter, leading to solid bottom-line growth.

The good news is that Synaptics expects this turnaround to continue, as its guidance numbers for next quarter (Q2 2019) show.

Item

Q2 2018 (Actual)

Q2 2019 (Guidance)

Revenue (in millions)

$430.4

$410 to $440

Non-GAAP gross margin (%)

35.90%

38% to 39%

Non-GAAP EPS

$1.11

$1.25 to $1.55

Source: Synaptics.

So, what has changed at Synaptics and is helping the company turn around? The two-word answer: product mix. Internet of Things supplied 22% of Synaptics' revenue last quarter, up from 14% in the prior-year period. Not surprisingly, Synaptics is now committing more money to this part of its business.

In the words of Synaptics CFO Wajid Ali, the company has "shifted a large portion of our investment dollars from in-display fingerprint to consumer IoT to enable stronger growth of IoT over the mid-term, which we believe will become more evident toward the end of our fiscal year."

Management's confidence regarding the growth of the IoT business seems justified, and the company is pursuing fast-growing opportunities within this space.

Synaptics is aggressively moving into the smart-speaker space by pushing the envelope in far-field voice technology. It is about to launch new products aimed at this market based on a new manufacturing node, which will start sampling at key customers in the next few weeks. This should help Synaptics boost its reach in the market for smart audio chipsets that are finding traction not only in smart speakers, but in other applications such as smart televisions and set-top boxes as well.

The good part: Synaptics has already won a contract to supply its audio chipsets to Alexa-enabled televisions from TCL. It won't be surprising to see the company score more deals in this area, because demand for smart TVs will increase at an annual rate of 9.5% through 2025, according to Grand View Research. But this isn't the only secular growth opportunity within the consumer IoT space for the company.

Synaptics has announced far-field voice solutions for set-top boxes as well. While set-top box manufacturers can integrate Synaptics' platform into their new products to add a voice assistant feature, owners of old set-top boxes can simply plug in a stand-alone USB accessory to make their legacy device smart.

This opens up a huge addressable market for Synaptics. More than 300 million set-top boxes were sold in 2017, a number that's expected to increase with the addition of smart features such as the voice assistants that Synaptics is providing. As such, the chipmaker is sitting on attractive opportunities within the IoT space that could help drive steady growth in its business in the long run.

Time to buy

Synaptics' IoT business should drive all-round growth in the long run. Management made it clear in the latest quarterly earnings call that the increasing mix of IoT revenue is "working favorably," so an increase in this segment's top line will boost the company's earnings profile.

That's probably why the company's earnings are expected to jump to $4.72 a share in the current fiscal year as compared to $4.05 a share last year. What's more, analysts expect the momentum to continue into fiscal 2020, which is why now seems to be a good time to get into Synaptics stock given its valuation.

The stock is trading at a forward P/E ratio of less than 8, while a PEG (price to earnings/growth) ratio of 0.61 further indicates that Synaptics is undervalued. As such, those looking for a budding IoT chip play for the long term need to take a closer look at this stock.

 

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.