Why Is Cypress Semiconductor Stuck in Neutral?

Shares of Cypress Semiconductor (NASDAQ: CY) rallied 33% last year, but the chipmaker's stock advanced less than 3% this year. That anemic growth compared poorly to the Philadelphia Semiconductor Index's 5% gain and the NASDAQ's 10% rally.

I own shares of Cypress, and I've repeatedly said that the chipmaker's market leading position in growing niche technologies (like wireless IoT chips, NOR and SRAM memory chips, USB-C controllers, and auto instrument cluster microcontrollers) made it a solid play on the automotive and industrial Internet of Things (IIoT) markets.

Wall Street still expects Cypress' revenue and earnings to rise 7% and 39%, respectively, this year. Yet the stock trades at just 13 times this year's earnings and pays a hefty forward dividend yield of 2.8%. So why is this stock still stuck in neutral? Let's examine the four main reasons.

1. Brewing troubles in China

Last quarter Cypress' revenues from the Greater China region slipped 7% annually, but still accounted for 37% of the company's top line. Cypress didn't address this slowdown during its conference call, but it was likely caused by slower sales of chips for connected cars and industrial machinery.

That was troubling, since other chipmakers fared better in China during the same period. Texas Instruments (NASDAQ: TXN), which provides a wide variety of analog and embedded chips for cars and industrial machines, reported that its sales in China rose almost 7% annually last quarter.

Meanwhile, escalating trade tensions between the US and China could exacerbate Cypress' pain in China with higher tariffs or other protectionist moves. China's growing support for domestic chipmakers, which it hopes will eventually replicate foreign chipmakers' tech, also raises tough questions about Cypress' future in the market.

2. Slowing auto sales

Global sales of light vehicles hit record highs for eight straight years through 2017 according to IHS Markit. However, the firm expects that growth to decelerate to just 1.7% this year, compared to 2.4% growth last year.

That deceleration convinced some investors to avoid automotive chipmakers like Cypress and Texas Instruments. However, those fears could be unfounded, since chipmakers' content share gains per vehicle could easily offset declines in auto shipments. Cypress previously claimed that new high-end connected cars use about $1,000 in chips -- compared to just $300 for older "basic" vehicles. Cypress also noted that its total automotive revenues rose 15% annually last year, which easily outpaced the auto market's overall growth.

Cypress' MCD (Microcontroller and Connectivity Division) revenues, which include revenues from its automotive chips, rose 6% annually last quarter and accounted for 58% of the chipmaker's top line. That growth indicates that concerns about an automotive slowdown are likely overblown.

Unfortunately, the Trump Administration's recent consideration of auto tariffs against the European Union, which could spark another trade war, is casting a dark cloud over the future of the auto industry and Cypress' long-term growth.

3. Waning interest in chipmakers and IoT stocks

The Philadelphia Semiconductor Index rallied nearly 40% last year, but cautious investors could be taking profits as valuations rise and trade tensions escalate. Meanwhile, the market seems to have fallen out of love with IoT stocks, possibly due to too many lofty promises and lackluster sales growth. For example, the IoT-focused Global X Internet of Things ETF remains down 3% this year.

Cypress' main growth strategy, dubbed "Cypress 3.0", aims to turn the chipmaker into a one-stop shop for IoT solutions. However, investors can also get similar exposure to the IoT market with bigger and more diversified chipmakers like Texas Instruments. TI, which claims to be the "only semiconductor company with all of the building blocks to enable the IoT," also supplies a wide range of wireless chips for wearables, smart factories, smart cities, home automation devices, and connected cars.

4. Rising interest rates

Lastly, rising interest rates will hurt Cypress in two ways. First, higher interest rates cause income investors to replace dividend stocks with bonds with comparable yields. The 10-Year Treasury's current yield of 2.9% is already higher than Cypress' forward yield.

Cypress also accumulated a lot of long-term debt with its merger with memory maker Spansion in 2014 and its acquisition of Broadcom's wireless IoT business in 2016. Cypress is gradually extinguishing that debt, but it won't clean up its balance sheet before interest rates hit even higher levels.

The bottom line

These four factors clearly make Cypress a riskier investment than it was last year. However, I believe that the concerns about trade tensions are overblown, and that its Cypress 3.0 plan remains on the right track. Investors who accumulate Cypress at these levels could be well rewarded as the connected auto and IoT markets flourish over the next few years.

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Leo Sun owns shares of Cypress Semiconductor. The Motley Fool recommends Broadcom Ltd and Cypress Semiconductor. The Motley Fool has a disclosure policy.