Doom and Gloom Set to Continue for This Apple Play?

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Cirrus Logic (NASDAQ: CRUS) is one of the most well-known Apple (NASDAQ: AAPL) derivative plays out there, as the company gets a substantial portion of its revenue from the smartphone behemoth (85% in the March quarter). Hence, it is not surprising that Cirrus has had a torrid time this year, with the stock down close to 30%.

Shares have been beaten up on more than one occasion this year as Cirrus felt the effects of product transition at Apple, leading it to issue depressing guidance for the fiscal first quarter, which it is due to report on July 25.

While a shallow outlook for the June quarter was more or less expected as Apple slowed down production of its older generation products and prepared for the new one, it looks like Cirrus’ woes would continue even as Apple ramps up production of the next generation devices. The company seems to be struggling with its gross margin and has met with a few downgrades in the past few months as a result.

Considering these, the upcoming earnings report and the guidance will be very important if Cirrus is to provide some relief to troubled investors.

On revenue

Analysts, according to Yahoo! Finance, are expecting Cirrus to post revenue of $160 million for the first quarter, which is right at the mid-point of the company’s own estimate of $150 million to $170 million. So, there shouldn’t be much difficulty in at least meeting this estimate, since Cirrus had reiterated this guidance at the Barclays tech conference as well.

However, this is much below the original expectation of $191 million by analysts, which means that the estimate has been revised downward substantially. Nevertheless, if Cirrus manages to achieve its revenue target, it would translate into an impressive growth of 62% from the year-ago period. So, the company should meet estimates and also turn in an impressive year-over-year growth figure, even though it won’t stand for much since the estimate is already low enough for it to stumble over it.

On earnings

Analysts are looking for earnings of $0.49 per share in the first quarter, impressively ahead of the $0.22 per share that it had reported in last year’s first quarter. The company has trumped earnings estimates in the last four quarters and it might do the same again. Cirrus had reported earnings of $0.59 a share in last year’s fiscal fourth quarter with a gross margin of 40.4%. Revenue in that period was $207 million.

However, management guided for a gross margin of between 50% and 52% for the first quarter. Since the gross margin is expected to grow strongly and revenue is expected to be down almost 22% on a sequential basis, one can count on Cirrus to at least meet the earnings estimate.

So, it seems that the company will at least satisfy the already depressed estimates, but the real trouble begins when one starts figuring out the possible outlook that Cirrus will issue.

Dark clouds ahead

While Cirrus management had stated that the company’s gross margin would return to the 50%-52% level in the first quarter on the previous earnings call, it caught everyone on wrong footing at the Barclays conference when the company stated that gross margin is expected to decline to the "mid-40's" range in the long run.

This sent the shares packing and a look at the analyst estimate table for the September quarter suggests that Cirrus’ growth is expected to halt. Analysts are looking for revenue outlook of $190 million, down 2% from the year-ago period, while the earnings projection stands at $0.54 a share, way below $0.79 last year.

It looks like Cirrus’ overdependence on Apple is coming back to haunt it. When shares of Apple were having a great time, so was Cirrus. However, it looks like there is some trouble in Cirrus’ Apple account, given the expected pressure on gross margin.

Rick Schafer, analyst at Oppenheimer, had stated (via Reuters) that there are a bunch of headwinds faced by Cirrus. Competition in audio codecs, which has been Cirrus’ permanent spot in the iDevices so far, margin pressures due to a lower-cost iPhone, and saturation of its Apple account are some of the reasons that he stated are behind Cirrus’ troubles.

There are a number of players who might unseat Cirrus for its codec spot and the same might have happened if analysts’ estimates for the September quarter, which is usually among the strongest for Cirrus, turn out to be true. Moreover, it might be possible that Apple was able to negotiate a lower price for the chips given its clout, further pressuring Cirrus.

And while a cheaper iPhone should have ideally increased the addressable market for both Cirrus and Apple, the low revenue projection suggests that Cirrus might have missed out on the cheaper version of the device, which is already reported to be in the production stage. Again, the expected lower cost of components for a cheaper iPhone might be another reason why a cheaper iPhone isn’t expected to be a catalyst for Cirrus.

Cirrus had to record an inventory reserve in the fourth quarter due to the transition at Apple, and if recent comments of management regarding gross margin are considered, it might do the same once again. Apple is beginning to ramp up production of the next generation iPhone, as reported by All Things D. It is expected that Apple will launch the new iPhone in the fall, and if that’s indeed the case, one should ideally expect Cirrus to issue a solid outlook.

Final words

However, given the company’s recent woes and analyst estimates, I’m not too optimistic about Cirrus at this point. It’s true that shares are trading at a dirt-cheap 9.7 times earnings, which is surprising for a company that’s delivering solid revenue and earnings growth. But, the low earnings multiple suggests that the market isn’t expecting much from Cirrus either, and if it issues a depressing forecast once again, then Cirrus’ cheap valuation would be justified.

Cirrus is neck-deep in trouble and desperately needs a turnaround. Check back here again in a few days after the earnings report to see how the company performed and where it is headed in the future.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Cirrus Logic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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