Income investors might think of picking up a stake in Cypress Semiconductor (CY +0.00%) considering its long dividend-paying history and a decent yield of 2.9%. In fact, Cypress pays out a really rich dividend in light of the fact that the technology sector's average dividend yield is just 0.9%.
However, Cypress is staring at short-term weakness because of weak semiconductor demand. But that shouldn't deter income investors from taking a closer look at this chipmaker because it is targeting fast-growing semiconductor niches.
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For instance, Cypress is witnessing impressive growth in the automotive market, which recorded double-digit growth last year and now supplies 36% of its top line. Also, the company saw a 24% increase in design wins last year, which should eventually result in long-term revenue gains once those wins translate into new business.
But these aren't the only reasons why dividend-focused investors should be looking at an investment in Cypress.
Cypress' cash flow improved last year
Cypress delivered a 57% increase in adjusted net income in fiscal 2018. The company swung to a GAAP net profit of $354.5 million, compared with a 2017 net loss of $80.9 million. Such a massive improvement in Cypress' bottom line positively impacted its cash flow profile, with cash flow from operations jumping close to 17% year over year in fiscal 2018 to $471.7 million.
On the other hand, Cypress' net capital expenditure for the year increased 21% year over year to $63 million. But Cypress' operating cash flow gained at a faster pace, so its free cash flow increased 16% in 2018 to $408.5 million.
The chipmaker's dividend outlay for 2018 stood at $157.3 million, which means that it paid out 38% of its free cash flow in the form of dividends. By comparison, Cypress' dividend expense in fiscal 2017 was $145 million, while its free cash flow stood at $351 million, translating to a dividend payout of 41% on the basis of free cash flow.
Including the $35 million that Cypress spent on share repurchases, the company used 47% of its free cash flow to return cash to shareholders in the form of buybacks and dividends. Now the company plans to return half its cash flow back to investors in the form of dividends and buybacks, so it won't be surprising to see it boosting its dividend in the future.
But to do that, Cypress needs to ensure that its cash flow improves, and that's only possible if its earnings increase.
Margin gains will drive Cypress' earnings
Cypress Semiconductor's gross margin has increased nearly 11 percentage points since 2016, when its strategy of going after fast-growing semiconductor verticals was launched. At the end of 2018, the company's gross margin stood at 47.8%, and it is aiming for a 50% gross margin level in the future.
However, it might take some time for Cypress to get there. The company's first-quarter revenue fell 7% annually, though its non-GAAP earnings rose 2% thanks to stronger margins. Cypress' gross margin came in at 47.4% during the quarter, an increase of 150 basis points over last year, while operating margin increased 160 basis points.
Looking ahead, Cypress believes that it can reach a gross margin of 50% and an operating margin of 25%.
Not surprisingly, analysts expect Cypress' earnings to increase to $1.22 per share next year after a slight dip this year, according to data from Yahoo! Finance. More importantly, they expect Cypress to clock double-digit earnings growth for the long run.
Given that Cypress stock is trading at 14 times forward earnings, now would be a good time for income investors to take a closer look at the stock despite near-term headwinds. Cypress has a nice yield and is planning to boost the dividend further, which looks like a real possibility once it gets its earnings growth back on track.
