It's been nearly two years since Lattice Semiconductor (NASDAQ:LSCC) CEO Jim Anderson took the reins, after leading AMD's (NASDAQ:AMD) Computing and Graphics segment for a few years. The results have been noteworthy. The stock has soared over 300% since the start of 2019, reflecting a refocusing on the company's core semiconductor portfolio and the resulting resurgence in profitability.  

It's true Lattice has gotten some external help. New computing power requirements for data centers, industrial equipment, and 5G mobile network construction have boosted demand for the small chip designer's field-programmable gate arrays (FPGAs). But there are plenty of other semiconductor companies that haven't executed nearly as well amid a U.S.-China trade war and now the coronavirus. 

Some of the company's customers have tapped the brakes this year due to pandemic-related issues, and there will be challenges ahead. Nevertheless, there could be plenty left in the tank for this small chip stock in the coming decade.

A picture of a Lattice Semiconductor FPGA chip on top of a busy city intersection.

Image source: Lattice Semiconductor.

Focusing on the most vital projects

FPGAs aren't new. The chips have become a commonplace feature of many electronic systems and devices, since the internal electronics can be changed post-manufacture (thus the "field programmable" part of the name). At just over $400 million in revenue over the last year and a market cap currently at $3.8 billion, Lattice is a tiny player in the industry. It goes up against Intel (NASDAQ:INTC) (via its acquisition of Altera for $16.7 billion in 2015) and FPGA leader Xilinx (NASDAQ:XLNX) (trailing 12-month revenue of $3.16 billion and a $22.7 billion market cap).

As with many other electronics hardware companies, diversifying into the design and sale of adjacent pieces of equipment is common, and Lattice was no exception -- that was, up until a couple of years ago. Under Anderson, Lattice cut spending on other projects to focus almost solely on the low-power FPGA market. Specifically, Lattice's newest high-speed chip designs come as small as a 6-millimeter-square footprint, and consume up to four times less power and are up to 100 times more reliable than some competing FPGAs.  

Ho-hum revenue, more profits

Walking away from revenue may not seem like a great deal. However, the renewed focus at Lattice has paid off. Its wares are finding plenty of demand in new applications, like connecting the various parts of communications equipment, providing computing support in data centers, powering automated industrial equipment and sensor functions, and controlling advanced features in today's cars (like electric powertrains and advanced driver-assist systems). Some of these industries are touch-and-go at the moment, but all represent areas of expected growth in the longer term.

The focused strategy has ultimately done little to change the revenue picture. Sales in full-year 2019 were $404 million (compared to $399 million in full-year 2018). And the state of current world affairs thanks to COVID-19 means a year-over-year decline could be in store, as many customers -- especially in the auto and broadcasting industries -- put projects on hold. First-quarter 2020 sales fell 1%, and the forecast for the second quarter called for as much as a 7% year-over-year decline.

More importantly, though, Lattice's refocusing on the low-power FPGA has paid off on the bottom line. Over the last three years, trailing 12-month operating profit margin and free cash flow (revenue less cash operating and capital expenses) have both gone from close to nil to 15% and $96.5 million, respectively. As to the latter metric, that's good for a free cash flow profit margin of 24%. Simply put, the core FPGA business is highly profitable and is generating good return on Lattice's invested capital. Previous projects, not so much.

Granted, this small semiconductor stock trades for a premium. Headwinds notwithstanding, shares have increased 46% to-date in 2020 due to optimism on 5G network rollout and strong data center demand amid shelter-in-place orders, as well as continued progress in electric vehicle and autonomy adoption. Shares thus trade for a premium 39.9 times trailing 12-month free cash flow.

That's a rich valuation, and I'm not quite ready to pull the trigger. Nevertheless, I'm adding this small semiconductor stock to my watch list. The laser focus on advancing the tech behind FPGAs has paid off, and with big and fast-growing end-market opportunities to tap into, I like Lattice Semiconductor's prospects.