Cirrus Logic For Apple Exposure

 |  About: Cirrus Logic, Inc. (CRUS), Includes: AAPL
by: Jim Fish

Cirrus Logic (NYSE: CRUS) is one of the many suppliers to Apple (NASDAQ: AAPL). CRUS provides "high-precision, analog and mixed-signal integrated circuits for a broad range of audio and energy markets". In the fiscal years 2010, 2011, and 2012, AAPL represented 35%, 47%, and 62% of revenue, respectively. Investors may see this as a risk, while others may see this as a strength. If AAPL were to switch away from CRUS (which there appears to be no indication of at this point), the company would suffer greatly. Also, the idea of AAPL squeezing its suppliers is a threat to CRUS. Margins have been under pressure lately for CRUS, with much of the Q2 call questions centering on the gross margin. However, if AAPL products continue to trend well and grow market share, CRUS will reap the benefits. The top 10 customers of CRUS accounted for 74% of its revenue in FY12.

I am certainly not a technology expert, as my area of interest and expertise is more on the consumer discretionary and household goods side. However, there appears to be a strong correlation with CRUS and AAPL given the large amount of revenue from AAPL to CRUS. Below are the stock returns for each company over the last 3 years (Source: Capital IQ):

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How close are these price movements? The covariance is 1.015, resulting in a correlation of 88.69%! Clearly, these two companies move together in the stock market. Thus, any divergence or convergence of one should lead to the other doing the same. This potentially provides an arbitrage opportunity for investors, and for small-scale investors to be able to buy into the AAPL social trend. Many younger investors do not want to buy a $500+ stock, even though from a fundamental standpoint, AAPL is cheaper. There is a mentality about stocks trading in the $20-$80 range that attracts more eligible buyers.

As of November 26, 2012, AAPL was up 3% intra-day but CRUS was down 62 bps. CRUS has fallen off of its own cliff since its earnings release on October 31, 2012. This falloff was due to the margin deterioration that is expected. Management did raise guidance though and initiated another $200M stock buyback program. It would also appear that from a technical basis, CRUS looks like a good entry point at $31 (Source: Capital IQ):

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CRUS definitely has some risks that may make investors stay on the side-line. However, it has outperformed AAPL over the last 3 years. My main point is: investors don't have to pay +$500 per share to get AAPL exposure. CRUS currently provides the correlation to AAPL and will continue to do so as long as its major customer is AAPL.

In doing a quick valuation using my approach, I obtained the following price targets given a bear, base, and bull analysis:

Target Bear Base Bull
DCF $ 31.03 $ 38.60 $ 45.09
P/E $ 36.89 $ 55.48 $ 74.34
EV/EBITDA $ 23.08 $ 34.33 $ 46.64
P/S $ 36.22 $ 44.08 $ 51.57
Target $ 31.80 $ 43.12 $ 54.41
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My base case assumes margins decline and revenue grows at 11.5%. My bear case was based on 5% growth and higher than expected COGS. My bull case assumes 18.5% growth through 2017 with COGS coming in slightly better than expected. My required rate of return is approximately 11%, which is in-line with the historical average expected return of the market. Given that the share price is hovering around $31 currently, below my 'bear' case scenario, and the return of my base case is greater than my required rate of return, CRUS looks like a compelling buy here.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CRUS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.