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4 Reasons to Buy Cypress Semiconductor After Its Post-Earnings Pop

By Leo Sun - Apr 29, 2019 at 7:00PM

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This niche chipmaker’s business hit a cyclical bottom during the quarter.

Cypress Semiconductor (CY) struggled in the second half of 2018 as demand for its analog, wireless, wired connectivity, and memory chips waned. However, its stock rebounded nearly 40% this year, and it recently impressed investors with a solid first-quarter report.

Cypress' revenue fell 7% annually to $539 million during the quarter, but still beat estimates by $4 million. Its non-GAAP net income rose 2% to $102 million, or $0.27 per share, which also topped expectations by $0.03.

A semiconductor on a circuit board.

Image source: Getty Images.

Cypress' growth initially looks anemic, but a closer look reveals four simple reasons to buy this oft-overlooked chip stock.

1. Approaching the bottom of the cycle

During the quarter, Cypress generated 58% of its revenue from its MCD (Microcontroller and Connectivity Division) unit, which sells analog, wireless, and wired connectivity chips.

The rest came from its MPD (Memory Products Division) unit, which sells NOR, NAND, SRAM, F-RAM, and other specialty memory chips. Here's how those two businesses fared during the quarter.

Segment

Sequential Sales Growth

Annual Sales Growth

MCD revenue

(12.8%)

(7.8%)

MPD revenue

(8.1%)

(6.9%)

Total revenue

(10.8%)

(7.4%)

Data source: Cypress Q1 earnings report.

Cypress' growth looks weak, but it anticipates -4% to +1% sequential sales growth during the second quarter, compared to the consensus forecast for a 2% decline. Excluding its NAND business (which was divested on the last day of the first quarter) from both periods, its revenue would rise 1%-7% sequentially.

This indicates that demand for Cypress' chips, which are used across the automotive, Internet of Things (IoT), and consumer electronics markets, is accelerating again.

2. Expanding margins

Cypress is the market leader in Wi-Fi/Bluetooth combo chips for IoT devices, auto instrument cluster micro-controllers, auto NOR flash memory chips, SRAM memory chips, and USB-C controllers. Bigger chipmakers frequently overlook these niche markets, which lets Cypress bundle together chips and maintain its pricing power. That's why its gross and operating margins expanded year over year during the quarter.

Non-GAAP

Q1 2018

Q4 2018

Q1 2019

Gross margin

45.9%

47.8%

47.4%

Operating margin

19.5%

24.5%

21.1%

Data source: Cypress Q1 earnings report.

Cypress' margins declined sequentially due to some softness in its auto and IoT markets, but it reiterated its long-term goal of boosting its gross and operating margins above 50% and 25%, respectively.

For the second quarter, Cypress expects a gross margin of 47%-47.5%, and for its non-GAAP EPS to dip slightly on a sequential basis due to the divestment of its NAND business. However, Cypress' rebounding sales and stable margins indicate that its core business hit a cyclical bottom in the first quarter.

A woman reading while sitting in an autonomous vehicle.

Image source: Getty Images.

3. A focus on higher-growth markets

Thirty-seven percent of Cypress' revenue came from automotive chips during the quarter, and 28% came from IoT chips. Cypress believes that these markets, which were soft spots in recent quarters, should grow significantly over the next few years and offset its dependence on legacy businesses like consumer electronics. It's now applying 85% of its research and development investments to the auto and IoT markets.

Cypress believes that its content revenues per high-end vehicle will nearly double from $93 in 2018 to $184 in 2023, and that its auto revenues should grow at an average rate of 8%-12% per year. Ford's (F 2.33%) recent first-quarter results, which featured aggressive investments in autonomous vehicles and mobility services, supports that rosy outlook.

As for the IoT market, Cypress believes that 75% of wireless connectivity solutions will require Wi-Fi/Bluetooth combo chips this year. This business, which generated a large portion of its revenue from the Nintendo (NTDOY -3.32%) Switch last year, should expand as the number of connected devices rise in smart homes and smart cities.

4. A cheap stock with shareholder-friendly management

Cypress trades at just 14 times forward earnings, and pays a forward dividend yield of 3%. It spent $40 million on dividends and bought back $5 million in shares during the quarter.

Cypress returned 45% of its free cash flow through buybacks and dividends since the second quarter of 2018, and it has a long-term goal of returning 50% of its FCF over the long term. That target isn't as aggressive as Texas Instruments' (TXN 1.28%) plan to return all of its FCF to shareholders via buybacks and dividends, but TI has a higher forward P/E, a lower dividend yield, and arguably less room to grow than Cypress.

Why Cypress still has room to run

Cypress is a cyclical stock, and investors who buy it before its revenue growth accelerates again could profit. It could still struggle if the auto and IoT markets don't grow as quickly as anticipated, but its low valuation and high yield should limit its downside potential.

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Stocks Mentioned

Cypress Semiconductor Corporation Stock Quote
Cypress Semiconductor Corporation
CY
Texas Instruments Incorporated Stock Quote
Texas Instruments Incorporated
TXN
$170.01 (1.28%) $2.15
Ford Motor Company Stock Quote
Ford Motor Company
F
$12.71 (2.33%) $0.29
Nintendo Co., Ltd. Stock Quote
Nintendo Co., Ltd.
NTDOY
$56.46 (-3.32%) $-1.94

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