Many semiconductor stocks might seem too hot to touch in today's frothy market. After all, the Philadelphia Semiconductor Index has rallied 40% this year, more than double the S&P 500's 19% gain.
But there are still attractive buys in thet sector. One such chipmaker is Cypress Semiconductor (NASDAQ: CY), which I recently bought for five simple reasons.
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1. The Internet of Things
Cypress acquired Broadcom's (NASDAQ: AVGO) wireless Internet of Things (IoT) business last year as part of its "Cypress 3.0" push to become a "one-stop embedded solutions provider" for the IoT market.
That acquisition merged Broadcom's Wi-Fi, Bluetooth, and Zigbee IoT product lines, its WICED brand and developer community, and all of its related intellectual property with Cypress' own analog and memory chips.
Connectivity solutions from that portfolio generated 28% of the company's revenues last quarter. That figure will likely rise as the number of connected IoT devices, including cameras, wearables, drones, cars, and smart-home devices, rises worldwide.
Back in 2014, Cypress estimated that the number of connected devices could hit 50 billion to 70 billion by 2020.
2. Automotive growth
One of the major growth markets of the IoT is the automotive one. The number of connected cars worldwide could soar from 5.1 million in 2015 to 37.7 million by 2022, according to Research and Markets.
Back in fiscal 2011, automotive revenues accounted for just 12% of Cypress' end market mix. By 2016, that hit 32% on surging sales of chips for infotainment and navigation systems.
Cypress expects its automotive revenues to grow at a compound annual growth rate (CAGR) of 8%-12% between 2016 and 2021. Cypress' content share in these vehicles will also keep growing.
For example, BMW's 7 Series used $23 worth of Cypress chips back in 2010, but it used $79 worth of chips in its 2016 model. As connected cars evolve into driverless ones over the next decade, Cypress' automotive chip sales should rise even higher.
3. Industrial growth
Another big IoT market is the industrial one, which is often referred to as the Industrial Internet of Things (IIoT). Chips for this market connect industrial machines to cloud services and each other, which boosts their safety and efficiency.
Between fiscal 2011 and 2016, industrial chips jumped from 19% to 24% of Cypress' end market mix. Cypress offers a wide range of programmable microcontroller units (MCUs) for "Industry 4.0" smart factories.
Cypress believes that the total addressable market (TAM) in Industry 4.0 solutions will grow at a CAGR of 9.8% between 2016 and 2021. Cypress believes that growth -- along with the consumer electronics market -- will generate "stable long-term" revenues.
4. Solid top- and bottom-line growth
These growth engines, along with Cypress' growing specialty memory and USB-C charging businesses, are expected to boost its revenue and earnings -- which are inflated by the Broadcom deal -- by 20% and 76%, respectively, this year.
Those figures should drop to 7% sales growth and 37% earnings growth next year, but Cypress' core businesses should remain strong over the next few years. Its gross margins should also keep expanding as it increases the utilization of the Fab 25 wafer fabrication facility that it acquired via its merger with Spansion in 2015.
Cypress also divested its Minnesota Fab facility to reduce costs, pivoted toward higher-margin products, rebalanced pricing across its portfolio, and focused on "higher density and more predictable" segments of the NOR and NAND flash markets.
5. A reasonable valuation and decent dividends
Cypress shares had rallied 34% this year at the time of this writing, but the stock still trades at just 13 times next year's earnings. That's a low multiple compared to similar analog and embedded plays like Texas Instruments, which trades at 23 times forward earnings.
Cypress' forward dividend yield of 2.8% is also higher than Texas Instruments' 2.4% yield, even though Cypress hasn't hiked its payout since 2012. Cypress generally prioritizes acquisitions and investments in its own business, but the dividend is still a nice added bonus.
The bottom line
Cypress still faces challenges in the analog and embedded market from bigger rivals like Texas Instruments and Broadcom, but it still has plenty of irons in the fire and solid footholds in the automotive and industrial markets. That's why I'm willing to buy Cypress instead of other bigger chipmakers.
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