Why Cypress Semiconductor Is Poised to Keep Its Growth Engine Humming

Hassane El-Khoury took over the reins of Cypress Semiconductor (NASDAQ: CY) in August 2016, and the new CEO didn't take long to establish his footprint on the way the company did business. In February 2017, El-Khoury unveiled Cypress 3.0, which was his vision of targeting markets growing at a faster pace than the overall semiconductor industry.

Since then, the company has made impressive progress on its strategy of selling embedded chips into niches such as automotive, consumer, and industrial products, as evident from its first-quarter 2018 results, which showed a 9.5% year-over-year jump in unadjusted revenue. More importantly, it now gets almost two-thirds of its total revenue from two segments that could keep growing at a decent pace for a very long time.

Pulling the right strings

IHS Markit estimates that the number of connected cars on roads will triple over the next six years, with sales expected to reach 72 million units by 2023. These connected cars are fitted with a bunch of advanced electronics features such as infotainment systems, advanced driver assistance systems (ADAS), and electronic instrument clusters.

These electronics require fast read-and-write times so they can boot up quickly. Additionally, they also need to process data rapidly to enable time-critical functions such as a collision avoidance in connected cars. Such tasks can't be performed by traditional hard drives because they aren't as reliable and fast as flash memory, and this is where Cypress' NAND and NOR flash memory offerings come into play.

Cypress' NAND and NOR flash memories can operate up to temperatures of 125 degrees Celsius (257 degrees Fahrenheit), meeting the qualification standards set by the Automotive Electronics Council. Not surprisingly, they are being used by companies engaged in the development of connected cars, and half of Cypress' NOR flash output is being consumed by automotive platforms.

For instance, automotive component suppliers Bosch and Denso recently chose Cypress' automotive-grade NOR flash memories for developing next-gen ADAS solutions. The good part: Bosch and Denso are the top two automotive OEM (original equipment manufacturer) suppliers globally, so Cypress can ride their coattails and tap the fast-growing ADAS market that's expected to grow 24% annually through 2021.

Cypress says it supplies its wireless connectivity chips to the top eight automotive OEMs. It is not surprising to see Cypress' automotive revenue increased 15% last quarter and now accounts for 34% of its overall revenue. By comparison, global car sales were up just 2.3% in 2017, which means that the Cypress 3.0 strategy is reaping rewards already.

But automotive isn't the only key growth driver for Cypress. Its consumer business supplies 31% of the top line, and it has some nice catalysts -- including the transition to USB-C technology -- that could boost the business in the long run.

The chipmaker is currently the leader in the USB-C market with a share of 38% thanks to its relationships with five of the top six PC makers. USB-C adoption is gathering impressive traction thanks to the technology's various advantages such as 50% faster charging over traditional ports.

IHS Markit estimates that the number of devices with at least one USB-C port will touch 5 billion in 2021 as compared to 300 million a couple of years ago. Assuming that Cypress keeps control over even 30% of this market, its USB-C shipments could grow massively in the next four years.

Cypress' foray into lucrative chip markets will bring more business, as the company claims that its design wins increased 23% year over year during the latest quarter. But more importantly, the chipmaker will grow profitably as its new ventures are proving to be margin-accretive.

Stronger margins in the cards

Cypress' gross margin shot up 660 basis points last quarter to 45.9%, helping the company post GAAP net income of $9.1 million as compared to a loss of $43 million in the prior-year period. Meanwhile, adjusted net income more than doubled to just over $100 million, and Cypress credited this to the "ramping of new products at attractive margins."

The chipmaker believes that it can hit a 50% gross margin level, and it has been undertaking smart steps to achieve the same. One such strategy is to move into niches where it can gain a product lead over rivals and sell its chips at a higher price. For instance, Cypress is extremely focused on Wi-Fi and Bluetooth combo chips, as a majority of the market is now moving toward this platform.

Cypress claims that it is currently leading this space and doesn't face any serious competitive threats. For instance, it is the only player in the market to provide a chip that enables multiple devices in a car to connect to the infotainment system and stream unique content to each device. This innovative product has helped Cypress land a premium customer in the form of German luxury carmaker Audi, which is already using its new automotive-grade Wi-Fi and Bluetooth combo chip in the 2018 A8 sedan.

More importantly, Cypress plans to cross-sell its combo chips into broader Internet of Things verticals thanks to their low power consumption, long-lasting life, and long-range coverage. This will positively impact its margins, since it costs less to sell a product to an existing customer than to acquire a new one.

Investors are getting a good deal

Cypress has posted a GAAP loss over the trailing 12 months, so it doesn't have a trailing price-to-earnings (P/E) ratio. But we saw earlier that it turned profitable last quarter, and it looks on track to expand its margins further. This is probably why Wall Street attributes a forward P/E ratio of 12 to Cypress, which is well below the industry's multiple of 27.7 times.

At this valuation, Cypress Semiconductor should be an enticing bet for investors looking to take advantage of booming tech trends.

10 stocks we like better than Cypress SemiconductorWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Cypress Semiconductor wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of May 8, 2018

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool recommends Cypress Semiconductor. The Motley Fool has a disclosure policy.