Cirrus Logic: Is The Market Pricing In More Than Just Lower Margins?

| About: Cirrus Logic, (CRUS)
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Cirrus Logic's (NASDAQ:CRUS) president and CEO Jason Rhode dropped a bombshell on the market at the Barclays Global Technology, Media and Telecommunications Conference recently. Let's have a look at some excerpts by CEO Jason Rhode:

Smartphones themselves are just a tremendously high volume opportunity. It is a very competitive market that's puts a lot of pricing pressure in our camp, that's something we need to be responsive to and make sure we are positioning our customers to be successful. And in that context of course as that market matures the growth slows a little bit. But the counter to that is if we are able to add additional features to drive an expansion in our camp.

So he is preparing us for what he is about to say…

We're getting a lot of pricing pressure in that space as you can imagine given the size of the market. So we do expect our margins to be more than the mid-40s range was we move into the second half of this calendar year. So that's obviously not what we want to hear or what anyone that's familiar with us really wants to hear but at the same time we feel good about our ability to stick with the model and make our model work in terms of revenue growth and operating profit.

Well, there was the bomb. Competition in the space is the reason for lower margins looking ahead. In fact, lower margins are coming sooner than later in the second half part of the year. Obviously going from 50% to 40% margins makes a big difference for the long-term picture of the company, however the question is, does this make that much of a big difference for the stock today, given the correction from the $45 level?

I think not. This is not an expensive stock. In fact, the balance sheet has no debt, the company is buying back stock and the P/E of the stock is south of 10. I also don't think the company's smartphone business with Apple (NASDAQ:AAPL) is going anywhere any time soon. Lower margins are one thing, but the stock has priced in much more than that.

And if indeed the market has priced in more than simple margin compression, what might this something else be?

The bigger question surrounding Cirrus Logic is the relationship the company has with Apple. While the company's close relationship with Apple is still strong, nowhere is it written that this might not change in the future. And when Apple provides 90% of Cirrus Logic's revenue, any change in Apple's supplier agreement with Cirrus Logic will obviously have very severe negative implications for the company.

So is this a possibility? The truth is that it's always a possibility. Rick Schafer of Oppenheimer made that point in a recent note to clients:

"Potential dual-sourcing at Apple, margin pressures at Apple, low cost iPhone bill-of-materials pressures, lack of content-increase opportunities and pricing pressure from Apple are all now much larger question marks."

The key word is, "potential dual-sourcing." Again, while I have no evidence of this, it is the only thing I can think of to justify Cirrus Logic's stock falling much further. Because in the absence of such an outcome, the stock is a buy at these levels, even with lower margins looking ahead.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.