U.S. Markets close in 4 hrs 7 mins

Forget Micron, Cypress Semiconductor Is a Better Chip Stock

Leo Sun, The Motley Fool

Micron (NASDAQ: MU) was one of the hottest semiconductor stocks in 2017. Its stock nearly doubled as rising memory prices boosted its revenue and earnings, and its rally continued throughout the first half of 2018.

But that party ended as memory prices peaked and concerns about trade tensions and tariffs convinced investors to take profits. Micron's growth decelerated in recent quarters, and analysts expect its revenue to grow just 1% in 2019, compared to 50% growth in 2018. Its earnings are expected to drop 14%.

A bull and a bear figurine.

Image source: Getty Images.

Micron's stock tumbled nearly 30% over the past six months, and investors could face more pain as DRAM and NAND prices slide and Chinese chipmakers move forward with their plans to produce cheaper memory chips. The bulls argue that Micron can offset those declines by selling more chips for Internet of Things (IoT) gadgets, industrial machines, and connected cars, and that the stock is cheap at 4 times forward earnings.

However, investors looking for a chipmaker with a steadier core business and less exposure to cyclical headwinds should take a closer look at Cypress Semiconductor (NASDAQ: CY), which focuses on less cyclical niche markets.

What does Cypress Semiconductor do?

Cypress doesn't directly compete against traditional NAND and DRAM giants like Micron and Samsung. Instead, it's a market leader in several niche markets: Wi-Fi/Bluetooth combo chips for IoT devices, auto instrument cluster microcontrollers, auto NOR flash memory chips, SRAM memory chips, and USB-C controllers.

Cypress also sells NAND chips for embedded devices, but it recently decided to spin off that business into a joint venture with SK Hynix to sell Cypress' SLC (single-level cell) NAND chips and develop next-gen NAND chips. Cypress will only retain a 40% stake in the JV when the deal closes next year, and it should significantly reduce its exposure to the cyclical headwinds that are hurting Micron.

Cypress generated 50.6% of its revenue from the higher-growth automotive and industrial markets last quarter, compared to 49.4% from the slower-growth consumer and enterprise markets. The bears often claim that slower auto sales or an economic slowdown would torpedo its auto and industrial revenues, but Cypress can offset those declines with content share gains in cars and machines with bundles of chips.

A woman sits in a driverless car.

Image source: Getty Images.

How fast is Cypress growing?

Cypress generates its revenue from two main businesses -- the MCD (Microcontroller and Connectivity Division), which generated 61% of its revenues last quarter, and the MPD (Memory Products Division), which accounted for the remaining 39%. Here's how those businesses fared over the past four quarters.

 

Q4 2017

Q1 2018

Q2 2018

Q3 2018

MCD

21%

6%

2%

11%

MPD

2%

15%

10%

12%

Total

13%

9%

5%

11%

YOY revenue growth. Source: Cypress quarterly reports.

But like many other chipmakers, Cypress offered a downbeat forecast for the fourth quarter due to some "softness" in its end markets. It expect a 2% annual decline to 3% growth in revenues for the quarter, but still expects to generate 7% sales growth for the full year.

Analysts expect Cypress' revenue and earnings to fall 5% and 10%, respectively, next year. Those declines will likely be caused by slowing chip demand across the broader markets, potential problems from rising tariffs, and the initial drag of its JV with SK Hynix.

However, Cypress states that the JV will be accretive to its revenues, cash flow, and gross margin over "the long run," and that its streamlined focus on "more predictable" markets will help it achieve long-term gross margins of about 50% -- compared to the high 40s in the second half of 2018. For comparison, Micron expects its non-GAAP gross margin to slide from the low 60s to the high 50s during the first quarter, and possibly contract even more as NAND and DRAM prices decline.

Cypress should also benefit from the long-term growth of connected and driverless cars, since its NOR chips and auto instrument cluster chips are widely used in ADAS (advanced driver assistance systems) and demand for its IoT chip bundles -- the core of its "Cypress 3.0" strategy -- will rise as automation increases across the industrial IoT market.

Stick with Cypress, but avoid Micron (for now)

Cypress and Micron both face slowdowns next year, but Cypress has a better diversified business and more irons in the fire than Micron, which is basically a "pure play" on rising and falling memory prices.

Cypress might seem like the pricier stock at 11 times forward earnings, but it also pays a forward yield of 3.3%, while Micron hasn't paid a dividend for over two decades. Cypress' leading positions in niche markets, along with its lower enterprise value of $5.5 billion (compared to Micron's EV of $43 billion), also make it a more attractive takeover target for bigger chipmakers like Texas Instruments.

Therefore Cypress might not seem like a screaming buy right now, but it could fare better than Micron over the long run -- especially if memory chip prices faces another multi-year decline.

More From The Motley Fool

 

Leo Sun owns shares of Cypress Semiconductor. The Motley Fool owns shares of Texas Instruments. The Motley Fool recommends Cypress Semiconductor. The Motley Fool has a disclosure policy.