Cypress Semiconductor (NASDAQ:CY) has been on a tear. After a lackluster 2018 that brought on a 17% decline, the stock has rallied 35% since the start of the new year as of this writing. The chip-making industry is a cyclical one, and our company of focus has been saying last year's slump would reverse course by the end of 2019. The big rally in share prices has been hastened by Cypress' results that demonstrate that's just what is happening.

First, the numbers

Though revenue was down again and adjusted earnings were flat year over year during the first quarter of 2019, Cypress' profit margin continue to improve as the manufacturer focuses on transitioning its operations. It's all about moving away from its legacy memory and connection products to WiFi/Bluetooth connection, Internet of Things (IoT), and automotive solutions. Though many of the company's products are still in the midst of a bear market, results have been impressive.

Revenue

Q1 2019

Q1 2018

YOY Change

Revenue

$539 million

$582 million

(7%)

Adjusted gross profit margin

47.4%

45.9%

1.5 p.p.

Adjusted operating profit margin

21.1%

19.5%

1.6 p.p.

Adjusted earnings per share

$0.27

$0.27

0%

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

The transition to newer product sales is responsible for the higher margins, which in turn helped Cypress deliver flat year-over-year profit even though revenue declined. Improving margin is an impressive feat -- it usually falls as revenue falls, especially for a company as small as Cypress. Nevertheless, this has been the ambitious plan all along. CEO Hassane El-Khoury had this to say on the earnings call:

Our Management team and employees continue to drive the company toward our goals of achieving higher than industry revenue growth at greater than 50% gross margin and greater than 25% operating margin targets, and also how fast our commitment of maintaining greater than 20% operating margin to market downturn as evidenced by our ability to deliver a 21% operating margin this quarter. 

Cautious optimism is good enough for now

With the bottom line holding up even during a cyclical downturn, there's a lot to like about Cypress Semiconductor right now. To further its evolution, the company completed its exit from the volatile NAND memory chip business at the end of the first quarter. While that means fewer sales going forward, the resulting joint venture with South Korean outfit SK hynix system ic will reduce expenses but still provide cash flow when the memory business does well.

An artist's illustration of the Internet of Things. Illustrations of everyday items like cars, cameras, and computers are displayed in honeycomb cells getting hooked up to the internet.

Image source: Getty Images.

There are also signs of an upturn for semiconductors, which management has been cautiously anticipating would happen as 2019 wore on. Excluding the offloading of the NAND business, revenue guidance for the second quarter is expected to be up 4.4% at the midpoint of expectations. Gross margin is again expected to be in the 47% to 47.5% range.

Cypress continues to invest heavily in smart-home and enterprise IoT solutions and automotive, with 85% of research and development dollars getting allocated there. It's paying off. El-Khoury said his company claimed several new design wins in the automotive space during the quarter. Since these new contracts tend to be long term in nature, it could lead to significant growth for some time. That will translate to other segments of the business as Cypress can cross-sell its microcontroller and memory products with its connectivity solutions.

That's good news for investors. Cypress says its auto segment will grow 8% to 12% a year for the next few years. At 37% of the revenue total in the first quarter, the high-profit division should equate to the higher overall margins management is targeting in the near future. Put simply, even though the stock has rallied big so far in 2019, Cypress Semiconductor is still worth a look.