On Oct. 9, Microchip (MCHP 0.56%) kneecapped semiconductor stocks following its earnings warning. According to the company, the weakness that it saw wasn't company specific, but instead the result of an impending "industry correction" that it expects "will be seen more broadly across the industry in the near future."
While many chip stocks, particularly small caps, were down high single digit to low double-digit percentages, Cirrus Logic (CRUS 0.86%), a company that has tremendous exposure to Apple (AAPL 2.11%) only sold off modestly.
Being highly dependent on a single customer is, as seen in this price action, can have its upsides.
Why did Cirrus hold up so well?
It has been widely reported that Cirrus Logic derives over 80% of its revenue from chip sales to Apple. Now, as I highlighted in an earlier piece, there are real risks associated with having such a high proportion of a company's revenue come from a single customer.
However, if a company's said major customer is doing extremely well in an industry that is otherwise uncertain or simply doing poorly, then that concentration becomes a source of strength.
In this case, there seems to be very robust demand for Apple's iPhone products (and Digitimes reports that Apple is ordering enough chips from its suppliers for 200 million units of iPhone 6 and iPhone 6 Plus), and new iPads (reportedly coming on Oct. 16) could help drive iPad unit growth, helping Cirrus Logic.
Exploring the whacky Cirrus Logic earnings-per-share picture
A look at current sell-side estimates for Cirrus' earnings per share for fiscal years 2015 and 2016, respectively, reveals expectations of $1.99 in the former and $1.54 in the latter. On the other hand, analysts expect that the company's revenue will grow 3.2% during fiscal 2016.
What's going on here?
Well, Feltl's Jeffrey Schreiner pointed out back in April that while he expects Cirrus to see top-line growth during fiscal year 2016, the company will also experience "headwinds from the full utilization of deferred tax assets."
In other words, Cirrus is likely to see its tax rate move up, hurting net income (and thus earnings per share) even as revenue grows.
Is Cirrus Logic a bargain?
So, let's assume that the high tax rate kicks during fiscal year 2016, leading to the drop in earnings-per-share that consensus estimates generally expect. This means that, at $19.13 per share (the most recent close as of writing), the stock is trading at roughly 12.4 times expected earnings.
Not dirt cheap, but it's certainly a significant discount to the current S&P 500 multiple of 18.47.
While there are no guarantees, I expect that Cirrus will report solid results on Oct. 29 for the most recent quarter, and I'm even optimistic that it will issue strong guidance.
Further, since Apple customers are well-known to be "loyal," any share gains on Apple's part should lead to a sustainable uptick in revenue for Cirrus. Of course, the big risk here is that Apple forces Cirrus' margins down given that Cirrus, which is highly dependent on Apple, likely has little power to say "no."
In light of my expectations of share gains on Apple's part, a low likelihood that Apple will switch chip vendors, and a very low forward multiple that seems to bake in a lot of the risk, I feel comfortable owning the shares.
Foolish bottom line
Small-cap chip component plays aren't the safest investments around -- not by a long shot. However, given that the rest of the chip space has just taken a beating, and given that Cirrus is likely immune to these weaknesses in light of the fact that most of its sales come from Apple, it may be worth considering for investors with higher-than-average risk tolerance.
