Better Buy: NVIDIA vs. Cypress Semiconductor

Many semiconductor stocks rebounded this year after being slammed in the second half of 2018 on concerns about tariffs and slower enterprise spending. That's why the Philadelphia Semiconductor Index rallied about 20% this year and outperformed the S&P 500 and Nasdaq.

Some chip stocks, like NVIDIA (NVDA 6.60%) and Cypress Semiconductor (CY), also outperformed that benchmark index. I previously compared NVIDIA and Cypress last June, and concluded that Cypress' milder headwinds, lower valuation, and higher dividend made it a better buy than NVIDIA.

Image source: Getty Images.

Cypress outperformed NVIDIA after that article was published, but its 11% decline was merely less painful than NVIDIA's 35% drop. Looking ahead into the rest of 2019, will Cypress fare better than NVIDIA?

Comparing NVIDIA's and Cypress' businesses

NVIDIA is the world's largest maker of discrete GPUs for gaming, professional visualization, and machine learning tasks in data centers. Its biggest rival in that market is AMD. NVIDIA also sells Tegra CPUs -- which power infotainment and navigation systems in cars, driverless platforms, and the Nintendo Switch.

Last quarter (NVIDIA's fourth quarter of fiscal 2019), 43% of NVIDIA's revenue came from the gaming market, 31% came from the data center market, 13% came from the professional visualization market, 7% came from the automotive market, and 5% came from the OEM/IP markets.

Cypress sells two main categories of chips. Its 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. Cypress sells a large portion of its chips to the automotive and industrial markets, and it notably produces the Nintendo Switch's Wi-Fi/Bluetooth combo chip.

Fifty-nine percent of Cypress' revenue in its most recent quarter (the fourth quarter of 2018) came from its MCD unit, while the remaining 41% came from its MPD unit. Cypress is currently spinning off the MPD's NAND unit into a joint venture with SK Hynix, which should reduce its exposure to plunging NAND memory prices.

Check out the latest earnings call transcripts for NVIDIA and Cypress Semiconductor.

Image source: Getty Images.

Which chipmaker is growing faster?

NVIDIA's growth hit a brick wall last quarter as its core gaming revenue plunged 45% annually and 46% sequentially.

The company blamed that slowdown on weak demand for its newer GPUs (particularly in China) and the end of the cryptocurrency boom -- which flooded the market with cheap cards. Competition from cheaper cards and a lack of compelling features for newer games exacerbated the pain.

NVIDIA's data center revenue also fell sequentially on sluggish enterprise spending, and its automotive revenue dropped sequentially on softer auto sales. In other words, NVIDIA's core growth engines sputtered out after years of robust growth:

Fiscal quarters shown. Data source: NVIDIA quarterly reports. YOY = year-over-year. EPS = earnings per share.

Cypress' results weren't as ugly as NVIDIA's, but the company also struggled last quarter as its MCD revenue stayed flat annually and fell 14% sequentially.

Cypress attributed the drop to "broad declines" across its core business units and lower orders of its wireless IoT (Internet of Things) chips caused by lower sales of the Nintendo Switch. Those declines were partly offset by the low-single-digit growth of its auto MCU and USB-C revenue.

Cypress' MPD revenue rose 4% annually but declined 4% sequentially -- mainly due to a 32% drop in its NAND revenue. That cyclical decline, which could be partly resolved by its JV with SK Hynix, was partly offset by stronger sales of its high-density NOR chips across the automotive, industrial, and enterprise markets. Here's how Cypress fared over the past four quarters:

Data source: Cypress quarterly reports. YOY = year-over-year. EPS = earnings per share.

NVIDIA's and Cypress' core businesses are different, so their margins aren't directly comparable. However, NVIDIA's gross margin is contracting as Cypress' is expanding. Last quarter, NVIDIA's non-GAAP gross margin plunged 610 basis points annually to 56%, as Cypress' non-GAAP gross margin expanded 240 basis points to 47.8%.

NVIDIA mainly attributes that decline to headwinds in the gaming market, while Cypress attributed its gains to supply chain improvements, the launch of higher-margin products, and the restructuring of its NAND business.

Forecasts, valuations, and dividends

Wall Street expects NVIDIA's revenue and earnings to decline 5% and 19%, respectively, this year. Analysts expect Cypress' revenue and earnings to fall 11% and 20%, respectively, this year -- but part of the drop can be attributed to the spinoff of its NAND business.

Both chipmakers are expected to post positive sales and earnings growth next year. NVIDIA's stock still looks a bit pricey at 24 times forward earnings, but Cypress looks cheaper with a forward P/E of 13. Cypress' forward dividend yield of 2.9% is also much higher than NVIDIA's 0.4% yield.

Based on these facts, I stand by my previous assessment -- Cypress' better-diversified business, focus on niche chip markets, lower valuation, and higher yield make it a better all-around investment than NVIDIA.