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Shares of Cirrus Logic (NASDAQ:CRUS) plummeted Friday after the company pre-released earnings. The main take away from the release was that margins would be down due to a $4.2 million dollar charge related to a production issue with an audio device that went into high volume production in March. Margins will drop to 50%, below previous guidance of 54%-56%. The issue will have a smaller impact over the next two quarters, as Cirrus works through the inventory of poorly performing devices. The news knocked shares down more than 10% at one point, before rebounding slightly to finish down 7% on the day.

Cirrus Logic's largest customer is Apple (NASDAQ:AAPL) and the company's growth has been tied in large part to its relationship with Apple. Cirrus Logic's chips are found in many of Apple's hottest products, including the iPad 2 and the iPhone, and Apple is responsible for nearly half of Cirrus's revenue. While Cirrus did not disclose the customer the chip was being produced for, analysts have been quick to point out that Apple release the iPad 2 in March, and had been experiencing some trouble supplying enough of the product to meet demand. CIrrus will most likely never reveal who the product was for, but even if it was not for Apple, it is a black-eye for the company.

While the $0.06 charge to earnings in the quarter is not an end of the world scenario, having a production issue with your largest customer is never good. The company should still earn about $1.29 this year, meaning it trades at about 13x earnings. However, the issue with Apple will bring into question the relationship Cirrus Logic has with Apple, and that could put further downward pressure on shares. I had previously written that I preferred shares of CRUS to those of Apple because of the limited upside I saw in Apple, given its large market cap. This event has shaken my confidence in Cirrus Logic, although I still find the valuation compelling.

I will likely add to my position on this weakness, as the low valuations and existing share repurchase program should provide a floor in the share price. However longer term this event will bring into question the ability of Cirrus to continue to secure supply contracts with Apple, so new product releases may add to volatility in the name.

Source: Cirrus Logic: Buying on Weakness but Anticipating Future Volatility