Should You Buy This Potential Turnaround?

Should You Buy This Potential Turnaround?

It looked as if the competition was eating chipmaker Cypress Semiconductor's lunch last year. Rival Synaptics was making steady gains and displacing Cypress' chips. As a result, Cypress is still seeing steep declines in revenue. But the company's recently released fourth-quarter report and management's outlook for the new fiscal year indicate that a turnaround might be in the cards. In addition, Cypress is making some good PR moves by showcasing its technology for wearable devices through Qualcomm's Toq smartwatch.

So, is Cypress really poised for a turnaround? Or will investors be disappointed once again this year after Cypress' flat performance in 2013? The answer isn't very simple, but a comparison of what's good and what's not about Cypress should give us a fair idea if it is a good investment right now.

The positives
Cypress has probably seen a strong increase in order patterns lately, as evidenced by a book-to-bill ratio of 1.08 in the fourth quarter, the highest since the first quarter of fiscal 2012. This metric stood at a mere 0.75 in the preceding quarter.

The robust increase in orders can be attributed to a number of things. First, Cypress' touchscreen controllers are finding applications in the automotive industry. It wasn't surprising to see that the company's revenue from the automotive segment was up 62%, year over year, in the previous quarter. Cypress can expect more growth in this segment this year and beyond, as auto sales in the U.S. are expected to hit their highest levels this year since 2006.

The automotive and the industrial businesses together accounted for 37% of Cypress' top line in the previous quarter. This year, management expects these two segments to record above-average growth, and the expected pickup in industrial activity should help overall revenue. An improvement in this segment would go a long way in helping Cypress achieve year-over-year revenue growth going forward -- in the previous quarter, revenue was down 7% from the year-ago period.

Some more positives
Also, Cypress had a whole lot of design wins to claim in its last quarterly report. Its touchscreen controller was selected by Samsung for the Galaxy Note 3. It entered into a partnership with Fujifilm to support Fujifilm's metal mesh sensors, and it won business at Seiko Epson, L-3 Communications, D-Wave Systems, and other companies.

Cypress is also training its eyes on the smart watch market and proudly advertised that its touchscreen controller is present in the Toq. According to TechInsights, Qualcomm might have chosen Cypress because of its "strong focus on touch accuracy and responsiveness combined with low power consumption."

However, the Qualcomm Toq is not the defining device among smart watches, even though it has got decent reviews. But then, according to Engadget, it is better than the likes of the Pebble smart watch, and the Toq's battery-saving Mirasol display is noteworthy. The Qualcomm Toq might not be a big seller, but Cypress has probably made a good move with its participation in this device.

The smart watch market, according to Juniper Research, is expected to grow to 36 million units in 2018 from just 1 million in 2012. TechInsights believes that "Cypress's presence within wearable technology devices is increasing," and this is certainly a sign of better things to come.

In addition, Cypress is aggressively controlling its operating expenses. The company has trimmed headcount and employed other moves, such as shutting down on Christmas. Good management of operating expenses is one of Cypress' priorities, and through such moves, it expects the metric to be down once again in the ongoing quarter, despite an increase in revenue. Robust OpEx management has helped Cypress grow earnings despite weak revenue, as seen by an 80% year-over-year jump in non-GAAP earnings in the previous quarter.

A bit of caution
Synaptics is one of Cypress' primary rivals, and investors should keep a close watch on its product development moves. Synaptics' business has been growing rapidly, as seen in a 44% jump in revenue in the recently reported second quarter, as its products continue to gain traction. For example, Amazonused Synaptics' touchscreen in the third-generation 7-inch Kindle Fire HD and the Kindle Fire HDX.

Cypress had supplied the touchscreen controller to Amazon for the Kindle Fire HD in its previous generation, but it looks like Synaptics has taken that slot away. In addition, investors shouldn't get carried away by Cypress' record book-to-bill ratio.

As mentioned earlier, Cypress' book-to-bill was at 0.75 in the third quarter, and the jump to 1.08 in the fourth quarter is no doubt impressive. However, in the second quarter last year, Cypress had an impressive ratio of 1.05, and it saw a rapid decline in the subsequent period. So, an increase in the order pattern should not be taken as a sure sign of a turnaround.

The takeaway
A turnaround is possible for Cypress, as the pros look heavier when weighed against the cons. However, Cypress needs to be consistent if it is to deliver in the long run and keep the orders flowing. The company is moving into the right areas and has some design wins to show for its effort. Also, a dividend yield of 4.20% is quite enticing and could be the deal-clincher for potential investors.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Cypress Semiconductor. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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