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Morningstar | Cypress Logs Another Solid Quarter; Maintaining $14 FVE

Cypress Semiconductor’s fourth-quarter results were in line with our prior forecast on both top and bottom lines. Automotive sales continued to grow at a robust pace while management highlighted a healthy pipeline of high-margin design activity for both automotive and smart home markets. That said, after incorporating management’s guidance for the upcoming quarter, we will maintain our fair value estimate of $14 per share. Shares jumped 5% in aftermarket trading and believe they are trading at a slight premium. We would recommend investors wait for a pull-back before building a position in the no-moat semiconductor company.

Sales in the fourth quarter grew 1.2% year over year to $604 million, which represented a 10% sequential loss. By technology solution, microcontrollers and storage products continued to grow year-over-year basis, both at 4%, though this represented a sequential slowdown of 7% and 6%, respectively. The slowdown was more pronounced in connectivity products, however, which declined by 20% sequentially (6% year over year), reflecting weakness in consumer products (such as Nintendo’s Switch) as well as the impact of weakness in China. Sales by end market made this more explicit, with total consumer sales (between microcontrollers, connectivity products, and memory) declining 27% sequentially and industrial sales declining 8% versus the third quarter. Automotive sales continued to standout, growing by 20% year over year to roughly $215 million in revenue, accounting for 35.5% of sales during the quarter, as content increases continue to outpace unit sales.

The addition of the higher-margin automotive sales also helped expand adjusted gross margins by 80 basis points sequentially to 47.8%. This margin improvement also highlights the firm’s successful efforts to improve both mix and factory utilization, which we expect to continue throughout our explicit forecast.

Despite the long-term growth story, management was cautious in its quarterly outlook, with more than 40% of sales coming from China (predominantly in consumer and industrial markets). Revenue is expected to decline sequentially by 11.5% to $535 million at the midpoint of guidance which implies a year-over-year decline of 8%.

Adjusted gross margins are expected to contract by more than 150 basis points sequentially to 46.2%. This is greater than the normal seasonal decline and is in large part due to the weak pricing environment in NAND. Cypress’ management continue to expect the planned NAND joint venture with SK Hynix to be completed in the second quarter, which will then keep the core business from being buffeted by the quickly shifting pricing dynamics of the commoditized NAND market. Once completed, management expect over 90% of the firm’s specialty storage revenue will come from automotive, industrial and enterprise markets. We continue to view these markets as more likely to generate switching costs, particularly automotive, supporting the firm’s positive moat trend.