By David Sterman
While other computer and smartphone makers have repeatedly suffered from price wars, Apple (NASDAQ:AAPL) always takes a different path. The consumer technology giant prefers to deliver the most advanced products at premium points.
Such an approach can create a great user experience, but can mean real headaches for tech suppliers that want to do business with Apple. To be selected by the company, you need to make heavy investments in research and development (R&D) to make sure your products are up to Apple's very high standards.
A pair of companies are meeting that challenge and are poised to flourish as Apple embarks on a new cycle of hardware releases. Shares of Apple have surged 20% this quarter in anticipation of that product refresh, and these companies look set to ride Apple's tailwind.
When I last looked at Apple's preferred supplier of audio chips, Cirrus Logic (NASDAQ:CRUS), back in April, its shares had just suffered a 43% plunge over the prior six months. That's the downside of a heavy dependency on Apple. Famine often follows feast when it comes to cyclical demand.
At the time, I thought shares began to look like a bargain, with a single-digit forward multiple. But that call was premature, and shares slipped a bit further. Belatedly, they are now moving higher.
Much of the renewed optimism for Cirrus and other suppliers is due to imminent launches of new iPhones and a wearable watchlike device. Hopes are rising that the new iPhones will sell well in the all-important Chinese market, if Apple can deepen its relationship with China Mobile, that country's largest wireless service provider (with more than 700 million subscribers).
Because Apple is so tight-lipped about its supplier base and production plans, there has been some controversy surrounding Cirrus Logic's role in Apple's future plans. Might Apple switch vendors? It's always possible, but recent industry commentary suggests the relationship remains firmly intact.
Still, 10.3 million shares of Cirrus are held by short sellers, which is the highest level since the end of May and represents 16% of the float and six days' trading volume. If the shorts are wrong, then a massive short squeeze might ensue.
However, analysts' estimates for the current fiscal year (which ends in March) have been rising, not falling, indicating that few on Wall Street doubt that Apple's relationship with Cirrus remains on solid ground.
The Soft Touch
While Cirrus has played a leading role in Apple's audio efforts, Cypress Semiconductor (NYSE: CY) has been a leading supplier of chips that facilitate the touchscreens in iPads and other devices. To be sure, Apple works with other vendors, such as Synaptics (NASDAQ: SYNA) and Atmel (NASDAQ: ATML), but Cypress is especially well-positioned to deliver a greater amount of content to Apple.
"Cypress can leverage its manufacturing assets and processes to help optimize cost for performance and best serve the highest volume opportunities," said analysts at Lazard, whose $16 price target is more than 40% above current levels. Lazard's analysts speculate that Cypress may play a key role in Apple's upcoming iWatch launch.
Shares of Cypress have been in the doghouse for an extended period, dropping 25% over the past two years while the Nasdaq composite index rose more than 40%. Much of the blame goes to a bungled launch of its previous touchscreen technology, known as Gen 4.
In recent meetings with analysts, Cypress management noted that the current Gen 5 hardware and software are performing more smoothly. The company anticipates robust demand in the coming year as Gen 5 systems start to ship to customers.
At first blush, Cypress looks to be a great dividend growth story. The company's dividend was given a 63% boost in 2012 to $0.44 a share, good for a nearly 4% yield. But management appears committed to keeping the divided at current levels for the near future, even as analysts see earnings per share rising from $0.54 this year to $0.85 next year.
Risks to Consider: A disappointing launch of Apple's new products, or a broader slowdown in consumer electronics spending would keep these stocks from rising.
Action to Take: Both of these companies generate considerable cash flow, sport strong balance sheets and generate solid margins. Short-term investors focus on quarter-to-quarter trends, but both Cirrus and Cypress are setting the stage for continued industry leadership through their heavy R&D spending.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.