Shares of Cypress Semiconductor (NASDAQ:CY) have rallied by double-digits since the company put the fourth quarter of 2018 in the record books. Business results are showing signs of a slowdown as China's economy cools, exacerbated by the trade war with the U.S. Nevertheless, the stock was trading at depressed levels after an ugly end to last year, and the long view for the chip maker still looks rosy.

The year Cypress dug out of the hole

2018 marked the year Cypress got back to black after operating at a loss for a few years as it did a makeover on its business. Now a leader in connectivity for autos, industrial equipment, and other "Internet of Things" devices, Cypress has enjoyed strong growth in demand as well as rising profit margins.

Metric

Full-Year 2018

Full-Year 2017

Change (YOY)

Revenue

$2.48 billion

$2.33 billion

6.4%

Adjusted gross profit margin

46.8%

42.2%

4.6 p.p.

Earnings (loss) per share

$0.95

($0.24)

N/A

Adjusted earnings per share

$1.36

$0.89

52.8%

Data source: Cypress Semiconductor. YOY = year over year. P.p. = percentage point.

All of that growth came in spite of fourth-quarter revenue increasing a mere 1% year over year. However, Cypress continues to push into new areas of the connectivity market, so even modest gains equate to big moves on the bottom line because of better profit margins on product sales. Some examples include the company's work for the auto industry, providing digital display and infotainment system technology for high-end models; the beginning of the 5G mobile network buildout, which Cypress provides infrastructure materials for; and USB-C quickly becoming the primary power and connectivity option in consumer products, which helped Cypress regain the top USB-C supplier position for last year.

More connectivity, less memory

Cypress is at the cutting edge of new connectivity options, and the chip maker continues to hone its focus on that area. However, the company still has exposure to the volatile and lower-margin digital memory market; 41% of total sales in the fourth quarter were derived from memory products.

After the conclusion of the first quarter of 2019, though, some of that exposure will go away. That's because the company remains on track to complete the divestiture of its NAND memory business to a new joint venture with South Korean outfit SK Hynix Systems. The deal will reduce revenue a bit, but it will also reduce expenses and provide more stable cash flow over the next few years. CEO Hassane El-Khoury had this to say about the deal:

After closing this [joint venture], we expect over 90% of our specialty storage revenue will come from automotive, industrial, and enterprise, where pricing has been stable over the last couple of quarters. We expect this stability to continue in 2019. 

An artist's illustration of the Internet of Things. A city skyline is pictured with illustrated mobile connections between phones, cars, and other devices

Image source: Getty Images.

China might be a problem

For the first quarter of 2019, Cypress said revenue should be $520 million to $550 million, down from $582 million in the first quarter of 2018. El-Khoury said his company is addressing economic weakness with some prudence:

The outlook remains uncertain, as there continues to be a fair amount of cautiousness in our channel, especially those serving China, where end demand has clearly been impacted. In the rest of Asia, the US, and Europe, we broadly felt the impact as customers cautiously navigate the uncertainty surrounding the trade, tariffs, as well as the disruptions related to factory relocations. 

It may take time for business to iron out, especially if the U.S. and China don't come to a trade agreement by the March 2 deadline. El-Khoury said that, in spite of question marks, it's not all bad news. Cypress' customers continue to invest in new designs (37% of the company's design wins in 2018 were for brand-new products). While still early, the outlook for the second half of 2019 is looking more stable as well.

And of course there are those improving profit margins. Even though revenue is expected to slide in the first quarter, adjusted gross profit margin on sales should be 46% to 46.5%, up from 45.9% last year. That should at least cushion the blow a bit in the short term. For the long haul, though, Cypress is still a good bet on the semiconductor industry as it helps lead the way in new connectivity solutions.

Nicholas Rossolillo and his clients own shares of Cypress Semiconductor. The Motley Fool recommends Cypress Semiconductor. The Motley Fool has a disclosure policy.