Cirrus Logic (CRUS) is a name that has historically been highly levered to smartphone giant Apple (AAPL), which has been somewhat of a double-edged sword. On one hand, Apple represents a non-trivial amount of business, which affords the company and its investors a certain degree of certainty with respect to future operating results, particularly as the iPhone unit growth story remains intact (even if the margin story doesn't). Unfortunately, while the top line story remains largely intact, investor concern has been focused primarily on the gross/operating margin line. While the most recent report was not the most encouraging one I've seen from the company, there's still an interesting long-term story here if Cirrus can successfully diversify its revenue base.
The Quarter And The Guide: Not Great, But What Else Is New?
In the most recent quarter, the company reported $155M in sales, which represented a healthy 57% Y/Y increase from the prior period a year ago, but still off of consensus estimates of $160M. The bottom line came in at $0.56/share, which exceeded analyst estimates of $0.49 and represented a near tripling of the $0.22/share earned in the prior period a year ago. Gross margins were down somewhat from 54% to 51.2%.
Unfortunately, the guide isn't particularly strong; against consensus of $190M, the guided range comes in at $170M - $190M. Gross margins also take a hit, falling between 46% - 48% (52% in the year-ago period). While the gross margin story here has been giving investors a sour stomach for quite some time (and a "glass half full" perspective would argue that it's been baked in), particularly as the trend there has been more than unfriendly, the deceleration on the top line is alarming. The midpoint of the most recently issued guide calls for a 7% haircut on the top line on a Y/Y basis. The saving grace is that opex has been kept in check, staying roughly flat Y/Y.
Despite what seems to be a doom and gloom story, I believe that there's still a credible story here for the more patient, and perhaps somewhat risk-tolerant, investor.
Diversifying From Apple: The First Signs Of Life
While the Apple business is lucrative and most likely sustainable (despite some vulnerability on the margin front, I do not believe Cirrus is likely to be displaced whimsically from the iPhone/iPad sockets), I don't expect any meaningful multiple expansion until the company can diversify significantly. As buyers of Cirrus at $40+ are painfully aware, heavy dependence on a single customer dramatically increases the company's risk profile.
The good news is that Cirrus noted on its most recent call that it was now supplying parts to another major smartphone vendor in what should be a substantial design. This is an excellent first step, and I would become significantly more bullish if I were to see that this were a sustainable and material trend on the revenue side of things. While I expect that this would likely have an incremental effect on opex (as larger designs are usually not catalog-products, and require further engineering/support through the design cycle of said product), I believe that this would not be looked upon unfavorably.
As I noted above, I do not believe that Cirrus's components (particularly audio) are as "commodity" as I have noted in previous articles, and as a result, I am incrementally more positive and hopeful that Cirrus will be able to differentiate against peers. The one point of concern, however, is that the high-end market for smartphones/tablets may be slowing non-trivially, which may limit the value add from strong competitive differentiation.
Even Apple Could Provide Some Relief
While the long-term investor is much more likely to be heartened by lessening Cirrus's exposure to Apple as a percentage of revenues, I still believe that even Apple could still drive top-line growth. It is apparent, from the teardowns of all of the iOS products from the highest end iPad to the iPad Mini, that Apple is a happy customer of Cirrus's products. This to me suggests that if Apple does - as is widely anticipated by the press and analyst community - introduce lower cost iPhone products intended to drive significant volume in geographic regions that typically have been unable to adopt Apple's flagship devices, Cirrus would likely stand to benefit handsomely. While this would not likely remedy the gross margin ailments, the top line would certainly benefit. The main unknown is the elasticity of iPhone demand with respect to price in regions such as China.
That being said, given Cirrus's share price volatility, I would expect that such a device introduction would serve as a fairly dramatic upside catalyst for the name, given both its small float and its rather high short interest (~16% of outstanding shares).
Shares Are Cheap, But Not Quite Deep Value
Cirrus trades at 2.24x book value and 4.86x EV/EBITDA, so shares are cheap, but given the weakening gross margin trends, as well as the apparently slowing revenue base, I would hesitate to characterize Cirrus as "deep value." There are other semi names that actually trade near what Cirrus trades at, but to Cirrus's credit, it does trade at a discount to peers Maxim (MXIM) (3.03x P/B, 8.77x EV/EBITDA). So, the argument that Cirrus is "cheap" will not in itself be a catalyst. In my view, the bullish thesis should look for the following:
- Diversification to other smartphone/tablet suppliers to lessen dependence on a single, margin-hungry player
- Stabilization in the gross margin profile
- Signs of consistent revenue growth
Investors already have the first, although more is required before the market at large will accept it, but the second and third may prove to be more elusive. At some point margins and sales will bottom and then begin to move up, but is Cirrus there yet? That's the $64,000 question that the bulls and the bears continue to contend over.
Conclusion: Not For The Faint Of Heart, But There Is A Story Here
Cirrus may be in the midst of a rough patch, and there may very well be additional downside to the name before the business fundamentals bottom and show signs of reversal in a number of key areas. While I remain hesitant to take a position in the name, more aggressive investors in this space may want to start legging-in to a position. While the growth story look broken today, there's still a rational case for being long the name for investors that believe in Cirrus's technological leadership, and its ability to defend its current major socket while diversifying into new ones.