Is Cypress Semiconductor Finally Ready to Rally?

Shares of Cypress Semiconductor (CY) rallied 7% on Feb. 1 after the chipmaker's fourth quarter numbers topped Wall Street's expectations. Its revenue rose 1% annually to $604.5 million, beating estimates by nearly $6 million. Its non-GAAP -- generally accepted accounting principals -- net income rose 25% to $131 million, or $0.35 per share, clearing expectations by two cents.

For the first quarter Cypress expects its revenue to fall 6% annually to $550 million, and for its non-GAAP EPS to fall 11% at the midpoint to $0.24 per share. Those estimates missed the consensus forecast for $558.8 million in revenues and an EPS of $0.26.

Check out the latest Cypress Semiconductor earnings call transcript.

Image source: Getty Images.

Cypress' mixed numbers don't seem great, but investors seem to believe that it remains one of the better picks in the cyclically weak semiconductor market. Let's dig deeper into Cypress' fourth quarter numbers to see if they're right.

The key numbers

Cypress' MCD (Microcontroller and Connectivity Division) unit sells analog, wireless, and wired connectivity chips. Its MPD (Memory Products Division) unit sells NOR, NAND, SRAM, F-RAM, and other specialty memory chips. The MCD unit generated 59% of its revenue during the fourth quarter, while the MPD unit generated the remaining 41%. Here's how those two businesses fared in terms of sequential and annual growth.

Source: Cypress Q4 earnings report.

During the conference call, CFO Thad Trent attributed the weakness of the MCD unit to "broad declines across most business units" and a decline in wireless IoT (Internet of Things) revenues caused by lower orders from Nintendo. Cypress supplies Wi-Fi/Bluetooth combo chips for the Nintendo Switch.

Those declines were partly offset by the low single-digit growth of its auto MCU and USB-C revenue, the latter of which grew "despite headwinds at major handset customers." Trent also noted that Cypress non-Nintendo wireless IoT chip revenues rose 20% annually in the second half of the year.

Image source: Getty Images.

Cypress' MPD business saw a 32% sequential drop in NAND revenue due to the cyclical downturn in traditional (NAND and DRAM) memory prices across the market. However, its pending joint venture with SK Hynix, which will spin off its NAND unit into a separate company, should significantly reduce the MPD unit's cyclical pressure (though also throttle its near-term revenue growth).

Its decline in NAND revenue was offset by the 7% growth of its NOR business, which it attributed to robust demand for high-end, high-density specialty storage applications across the automotive, industrial, and enterprise markets. Cypress increased its average NOR density per chip by 15% annually in 2018, and its chips now have more than four times the density of the average NOR chip. Two-thirds of its 2019 NOR business is already locked in with long-term contracts.

Simply put, Cypress' focus on niche memory chips should help it weather the cyclical headwinds across the memory market better than many of its industry peers.

Margins and earnings growth

Cypress' total revenue growth was weak, but its gross and operating margins significantly expanded during the quarter.

Non-GAAP basis. Source: Cypress Q4 earnings report.

Cypress attributed its expanding margins to supply chain improvements, its ability to launch new products at high margins, and the aforementioned restructuring of its memory business, which will jettison its NAND business.

However, Cypress expects gross margin to dip to 46%-46.5% for the first quarter, partly due to the impact of the NAND business and its projected decline in revenue, which Trent attributes to both "normal seasonality" and "market uncertainty".

In other words, Cypress isn't sure how long the slowdown in semiconductor demand, challenges in China, and other macroeconomic issues will last.

Should you chase Cypress' rally?

Cypress' fourth quarter numbers look solid, but its outlook for the first quarter indicates that we haven't hit the bottom of the semiconductor cycle yet. However, its decision to spin off its NAND unit was smart, and its dominance of growing niches (like high-density NOR chips and USB controllers) could help it outperform many larger chipmakers which are exposed to commoditized markets. Cypress' low forward P/E of 13 and its forward dividend yield of 3.2% should also set a floor under the stock, even as its revenue and earnings decline slightly this year.

Investors who buy Cypress today likely won't reap big gains tomorrow, but they could be well-rewarded over the next few years as its long-term tailwinds in the automotive, industrial, and enterprise markets pick up again.