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On a day free of major market news, Cirrus Logic (Nasdaq: CRUS ) fell 8.6% today. Look around for explanations on the company's drop and you'll find no analyst chatter or company news to explain the drop in Cirrus Logic. Today, however, negativity did build around its number one customer -- Apple (Nasdaq: AAPL ) .
The fact that most analyst chatter surrounding Apple today was overwhelmingly positive -- as it has been during the past week -- didn't stop the company's shares from sliding 2%. Reading the market's mind on any given day can be an exercise in futility; but it's impossible to ignore, because a company is often traded on its exposure as a key Apple supplier. Shares of Cirrus suffer on days when Apple heads south.
Woes in recent months?
Today's suffering gives me an opportunity to look back at Cirrus' recent share price struggles. Since reporting blowout earnings after the market closed on October 31, Cirrus is off a whopping 31%.
Falling by over 31%, and blowout earnings, normally don't go together; but, in Cirrus' case, an analyst downgrade of the company's stock to "hold" seemed to spook investors. Chief among the concerns was that Cirrus saw gross margins decline a few percentage points from their historical norm to the "low 50s."
Never mind that Cirrus' gross margin decline of two-to-three percentage points came with concurrent 134% sales growth next quarter.
Never mind that Cirrus had significantly increased content for the iPhone.
Never mind that the analyst who downgraded Cirrus Logic set a price target of $44, precisely 57% above where the company trades today.
Never mind all these factors; Cirrus was seeing margins decrease a few percentage points, and investors had to sell!
No growth on the horizon?
The end result of all this is that Cirrus Logic trades for 20 times next quarter's adjusted earnings! No, not next year ... next quarter. Take the view out another quarter, and Cirrus is trading at eight times its expected adjusted earnings in fiscal 2013. That's even more impressive when you consider that one of the quarters in fiscal 2013 was before Cirrus massively expanded its partnership with Apple.
However, while margins were the main story line post-earnings, I'd argue that they're not the anchor that'll be holding Cirrus back in the coming months. Instead, the anchor will be Apple itself.
There's little doubt that the vast majority of Cirrus' projected future earnings growth is tied to Apple. So, looking at how the market values Apple shows what kind of growth is expected for Cirrus, as well.
With Apple now trading for less than 12 times earnings -- 8.5 if you exclude cash -- there's not a lot of earnings power baked into Apple's share price. The questions facing the company are two-fold: where can it find new growth, and can it maintain its margins as smartphone growth shifts to emerging markets?
From that angle, seeing Cirrus Logic trading at eight times this year's projected earnings isn't wholly out of line. It's a supplier that could be squeezed by Apple, or dropped from its products; therefore, there's a good case for the company to trade at a discount to Apple itself. In the past, Cirrus Logic traded at a premium to Apple, but the kicker was always expansion in future products and some other growth options, such as its plans in the energy space. With a huge surge of content in the newest iPhone, at least in the market's eyes, that driver is largely played out.
In defense of Cirrus
Of course, if you believe that the market has become overly bearish on Apple's future, that presents plenty of upside for Cirrus. I see a few scenarios that make me bullish on Cirrus headed into the year ahead.
- I believe that current pessimism around Apple is overdone, and demand for iPhones in the year ahead is higher than currently baked into the company's share price.
- It's also my belief that the iPhone mini will eventually become the standard iPad, far outselling its larger cousin. For Cirrus Logic, an iPad unit that's cheaper, but sells more units, is a very positive situation.
- Apple TV still isn't assured, and could come in many different forms. However, while it wouldn't move the volume of either an iPhone or iPad, it's also a product from which Cirrus could receive a higher sales volume per unit.
Make no mistake, Cirrus is heavily levered to not only Apple's sales, but to maintaining a good relationship with the company. If you're an investor getting skittish about Apple's growth, but still want to play its suppliers, a company like Qualcomm (Nasdaq: QCOM ) , which benefits from general mobile trends, might be a better play.
However, for my money, I'm keeping my investing dollar in both Cirrus and Apple in the year ahead.
Expert advice you can count on
As I noted above, it's in the central interest of investors in Cirrus Logic to understand Apple's remaining opportunities. However, there's a debate raging as to whether Apple remains a buy. I'm prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company -- and more importantly, your portfolio -- going forward. To get instant access to my latest thinking on Apple, simply click here now.