Downgrade Alert: What's Going on With Cirrus Logic?

Yesterday, Feltl's Jeffrey Schreiner downgraded shares of Cirrus Logic (NASDAQ: CRUS  ) , a mixed-signal/analog chip designer known for its high exposure to Apple's (NASDAQ: AAPL  ) products, on expectations of continued bottom line weakness. The arguments that underlie this expectation are worth exploring in detail for anybody interested in investing in Cirrus.

It's still all about Apple
When Apple was flying high, it brought Cirrus along with it, helping it to grow from a fairly obscure $5 stock to a momentum chip darling over the course of several years. However, as Apple's iPhone growth rates slowed to a crawl, Cirrus was negatively affected in two meaningful ways:

  1. An iPhone growth slowdown means that the sales of the audio CODEC and audio amplifiers that Cirrus provides Apple also slow down (this is over 80% of Apple's revenue, so the effect is quite pronounced).
  2. With Apple fighting decreasing smartphone prices and trying to keep margins at bay, it will squeeze suppliers that it knows have no choice but to make price concessions. If Apple dropped Cirrus as a supplier, Cirrus would probably be a $5 stock again.

So, you've got margin pressure and you've got slowing sales growth. On top of that, it's not getting any cheaper to design/build these chips -- R&D expense in the most recent quarter was up to $32.42 million from $29.61 million in the year-ago period, a 9.5% increase. Revenues were down from $300 million to $206 million, and gross margin percentage was down to 47.4% against 51% in the year-ago period.

Is there any hope?
Even with all of that said, the shares aren't particularly expensive, trading at just over 7x the current year consensus and 11.5 times next year's consensus. This isn't a mind-blowingly cheap stock, particularly as the company's deferred tax assets begin to wear off by FY2016, but it's not a crazy high flier that needs much to move.

What, then, could reverse Cirrus' fortunes? Well, these are the "obvious" things to look for:

  • An acceleration in iPhone/iPad sales over at Apple
  • Additional content sharing within Apple (granted, this seems pretty unlikely near-term)
  • Diversification into other high volume customers (although other CODEC vendors such as Qualcomm will be difficult to displace over at the likes of Samsung

It really does look as though Cirrus' fortunes are driven first and foremost by Apple's success and its ability to secure wins (at reasonable margins) over at Apple -- for better or worse.

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