Cypress Semiconductor (NASDAQ: CY) has grown rapidly in recent years. Its stock rallied 25% this year to a two-year high, and that momentum could continue on rising demand for its chips. It might seem risky to buy Cypress at current levels, but I believe it could still have room to run.
What does Cypress make?
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Cypress produces a wide variety of chips for the automotive, industrial, home automation, medical devices, and consumer electronics markets. It's the world's only maker of PSoCs (programmable system on chips), which can be reprogrammed and reconfigured for a wide variety of purposes.
Cypress' core business strategy is to continuously expand by buying up smaller companies. Its most recent acquisitions include the embedded chipmaker Spansion in 2015 and Broadcom's (NASDAQ: AVGO) IoT unit in 2016.
Cypress lets its subsidiaries operate with a degree of autonomy, but it also integrates some of its own technologies into those operations to accelerate the development of new products. That's how it developed its flagship PSoC products for embedded systems.
How does Cypress make money?
Cypress reports its revenues in two divisions -- the MCD (Microcontroller and Connectivity Division) and MPD (Memory Products Division).
The MCD unit includes its programmable chips, data connectivity products (including Broadcom's former IoT business), the foundry business for its emerging tech division, and the patents to its memory products. The MPD business sells NOR flash chips, SRAM chips, and specialty and non-volatile DIMM memory.
Cypress' MCD business generated 61% of its revenues last quarter, while the MPD business generated the remaining 39%. The MPD business usually grows at a slower rate than the MCD business, and it previously struggled with cyclical demand for memory products.
To solve that imbalance, Cypress stopped selling lower-margin memory products to provide pricier, higher-margin custom solutions for the automotive and industrial markets. It also cut costs and reduced its investments in the MPD business, enabling it to invest more heavily in the higher-growth embedded chips in its MCD portfolio.
How fast is Cypress growing?
Cypress is riding high on several strong tailwinds. First, the growth of the industrial internet (the Internet of Things for industrial machinery) is lifting sales of its industrial chips. Second, the rise of connected cars is increasing demand for various automotive chips. Sales of industrial and automotive chips accounted for 49% of Cypress' revenue last quarter.
On the consumer electronics front (35% of its sales), Cypress supplies the chips for USB-C connectors, which are quickly displacing older USB standards. It also supplies wireless chips for Nintendo's popular Switch console. Lastly, supply constraints across the memory market lifted prices of memory chips worldwide, giving its MPD business a shot in the arm.
All those factors boosted Cypress' total revenues by 30% annually last quarter, marking its fourth straight quarter of accelerating annual sales growth.
Analysts expect its revenue and earnings to respectively rise 20% and 63% this year. That figure was boosted by the Broadcom deal, but once annual comparisons normalize Cypress is still expected to post 6% sales growth and 41% earnings growth next year.
The stock is surprisingly cheap
Cypress' trailing P/E is negative due to the impact of recent acquisitions on its GAAP earnings. However, it trades at just 17 times next year's earnings -- which is cheap relative to its earnings growth rate. It also pays a forward dividend yield of 3.1%.
That low valuation and high dividend make Cypress a smart alternative to bigger chipmakers like Broadcom and Texas Instruments (NASDAQ: TXN). Broadcom trades at just 14 times forward earnings, but it pays a much lower forward yield of 1.7%. TI has a higher forward P/E of 21 and pays a lower forward yield of 2.3%.
The key takeaways
Cypress deserved to rally over the past year, and I believe that it could still have room to run. Surging demand for chips across the IoT, automotive, and memory sectors should bolster its core business, while newer USB-C devices and the Switch could strengthen its consumer electronics business -- which has been a rough market for many chipmakers in recent years.
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