Better Buy: Skyworks Solutions vs. Cypress Semiconductor

This year hasn't been a good one for the semiconductor industry. As measured by the PHLX Semiconductor Index, the industry is down 4% on the year, coughing up double-digit gains it was sporting through the summer months.

For Skyworks Solutions (SWKS 1.81%) and Cypress Semiconductor (CY), the losses have been worse than average -- the two stocks are down 27% and 16%, respectively. There are numerous reasons for the declines: the trade war between the U.S. and China, a contraction in the global smartphone industry, and falling prices in some types of memory chips. Nevertheless, both stocks now look like bargains, especially considering the growing importance of connectivity solutions as the world migrates to a digital economy.

Ttm = trailing 12 months. Data source: Yahoo! Finance, YCharts, Skyworks Solutions, and Cypress Semiconductor.

An enabler of the connectivity revolution

Skyworks Solutions is a leading network connectivity chipmaker for various devices, though it made a name for itself as a key Apple iPhone supplier. The company is down on its luck due to lackluster guidance issued for its first quarter of fiscal year 2019, the result of a slowdown in global smartphone sales. Revenue is expected to decline 3% to 5% from a year ago. 

Indeed, that has been the story at Skyworks the last few years as the trajectory of smartphone adoption around the globe has flattened. That has turned the company's sales cyclical, even as new uses for its chips in devices like watches, cars, and industrial equipment has surged. That trend is expected to continue: CEO Liam Griffin said on Skywork's fourth-quarter 2018 earnings conference call that the number of connected devices is expected to increase three times the current count to 75 billion by the year 2025.

In addition, Skyworks is set to be a beneficiary of the new 5G network as coverage expands around the globe. That's because the company has a portfolio of 5G equipment that helps power the network and connect devices to it. Thus, in spite of this year's ugly performance for the stock, analysts see a big rebound in 2019. Skywork's current forward price to earnings (PE) ratio reading is 8.6, versus a trailing-twelve-month PE ratio of 13.9. That implies a big increase in the bottom line over the course of the next year as Skyworks starts to benefit from 5G and improving smartphone sales.

Image source: Getty Images.

The new kid in the connectivity industry

Up until a few years ago, Cypress Semiconductor's primary business was the manufacture of commoditized memory and microcontroller chips. After a couple of acquisitions, the company has transformed itself into a maker of connectivity solutions and specialized microcontrollers for the auto industry, consumer products, and industrial manufacturers. The resulting connectivity business is expected to grow 16% to 18% annually through 2021, while the microcontroller segment is slated to expand by 5% to 7% each year over the same period.

That has led to steady growth in the last couple of years, and the stock has rallied accordingly: Shares are up 34% since the start of 2016, even after this year's pullback. Total revenue has increased by 8.6% through the first three quarters of 2018 against the prior-year period, and earnings per share in the first nine months have improved to $0.23 compared with a $0.14-per-share loss last year. With total sales expected to maintain a high single-digit growth rate, Cypress' one-year forward PE ratio sits at only 11.1 as it continues to distance itself from the losses it was running in the not-so-distant past.

That means that Cypress should be a big beneficiary from the connected things movement that Skyworks is also betting on, but with the added ability to cross-sell its microcontrollers to customers. However, Cypress still has exposure to the memory-chip industry; pricing on those semiconductors has been in decline in 2018, the key contributor to the stock's fall. Nevertheless, the company recently took action to reduce its exposure to its legacy products by contributing its NAND memory manufacturing to a new joint venture with South Korean chipmaker SK Hynix System IC. That move will reduce operating costs and further improve profit margins, strengthening Cypress' new core operations.

Which one is a buy?

Both companies appear to provide compelling value right now, although Cypress stock has already rebounded over the last few years after its emergence as a serious player in the high-growth chipmaking sector. Skyworks has been hit hard from the smartphone slowdown, but expectations are for a rebound in global sales next year. Plus, the company's portfolio of 5G network solutions opens up a new growth catalyst in the years to come. Given the stock's lowly forward PE of 8.6, I think now's the time to buy Skyworks Solutions while investor pessimism is running high.