Cirrus Logic’s Current Valuation Seems Less Than Completely Logical

A carefully cultivated skepticism can be an investor’s best friend, and when a stock looks too cheap, it’s absolutely a good idea to wonder why. In the case of Cirrus Logic (NASDAQ:CRUS), I understand concerns about the company’s heavy reliance on Apple (AAPL) and a soft outlook for smartphone units in CY’23, but even with those concerns accounted for, the share price here looks surprisingly attractive.

I like the efforts the company has taken to diversify beyond its long-held strength in audio, and I think there is still plenty of room for the High-Performance Mixed Signal (or HPMS) business to grow from here. I likewise think additional M&A deals are more likely than not. All things considered, then, I think this is a name where readers might want to consider some due diligence and investigation of their own.

Weaker Smartphone Sales Feel Like A Known Risk

I don’t think a relatively soft outlook for smartphone sales in CY’23 (including Apple, Samsung (OTCPK:SSNLF), and Chinese OEMs) is anything new now, as seen in the roughly 35% one-year declines at Qualcomm (QCOM), Qorvo (QRVO), and Skyworks (SWKS). Chinese phone volumes have already been hit hard (down over 20% in some cases), and while iPhone units could be comparatively weaker next year (down maybe 5% to 10%), again I don’t think this is anything that isn’t already anticipated by the market.

Could things get worse from here? Decades of investing have proven to me that the answer to that question is always “yes”. I do expect a weaker economy in 2023 and it’s plausible that weaker consumer spending could drive shortfalls relative to these expectations. I don’t think the market, iPhones in particular, are going to fall off a cliff, though.

Even with weaker unit volumes, Cirrus has its own drivers that can offset that risk. Cirrus has made meaningful progress over the years with content growth at Apple, including camera controller and power conversion products, and I don’t think that process is finished yet. Likewise, while building content at Android OEMs has been a more frustrating process, there’s nevertheless still content opportunities for Cirrus that can help offset volume risks. Likewise, I think there’s more unit volume risk in lower-end models, and that should generally be favorable for Cirrus.

Continuing To Expand The Attach Wins

Cirrus has done a commendable job of “land and expand” content growth with many customers, Apple included. Not all that many years ago, Cirrus’s content with Apple was largely just a limited number of amplifiers and codecs (1 each in the iPhone 6) and that has since expanded to multiple amplifiers, smart codecs, camera controllers, and power conversion/control chips.

On top of this, Cirrus has benefited from Apple’s willingness to use its products outside of phones. The company has won slots in AirPods (a codec and amplifier), and considering the number of Apple products that have audio and camera capabilities (not to mention power control needs), there could still be material content growth opportunities.

Cirrus has also been pursuing opportunities outside of the Apple ecosystem. The company has started designing codecs and amplifiers specifically for the needs of laptops and the company has over 40 laptops with their content coming to market this year. The company has charging and haptics drive business with Android OEMs that I believe can expand from here, and adaptive noise-canceling headsets and auto voice-enabled controls are potential markets well worth watching.

I see opportunities for Cirrus to leverage the technology it acquired in the Lion deal (switched-capacitor charging) and its own internal power conversion/control to address more opportunities within consumer electronics. Analog players like Analog (ADI), NXP Semiconductors (NXPI), onsemi (ON), and Texas Instruments (TXN) have all backed away from power management products in the consumer/phone space in favor of pursuing opportunities in end-markets like autos and industrial products.

There are good reasons for this (greater customer bargaining power, lower margins, volatile unit volumes), but it does leave some worthwhile opportunities on table for Cirrus – hyenas may get bad press, but they seem to do okay for themselves cleaning up after the lions.

Along similar lines, I see plenty of room to expand the HPMS business. Management has said that they want this unit to generate around half of the company’s revenue (versus 38% today), and I see a lot of incremental opportunities – winning camera controller, haptics driver, and power content with other consumer device companies, expanding into adjacent markets, and using M&A to broaden the product portfolio.

The Outlook

Cirrus was one of the relatively few companies to both raise guidance for the December quarter and guide to sequential growth. I do have some concerns tied to ongoing supply issues (getting enough wafers for its amplifiers and at reasonable prices), and even more so given the declines in inventory (from 127 days in FQ1’22 to around 57 days in the last quarter). I’d also note that there’s a history of volatility here, with runs of strong quarterly performance often followed by a quarter or two of correction.

I’m expecting around 4% revenue growth this fiscal year and similar growth next year, in the former case I’m in-line with the sell-side average and in the latter I’m a bit below the average. Longer term, I’m expecting around 5% to 6% annualized revenue growth.

I do expect ongoing margin pressure through this fiscal year and into the next, with operating margin declining from 26.5% last year to around 23.8% this year and 23.75% next year before a 100bp-plus rebound. Longer term, I think Cirrus can achieve adjusted free cash flow margins in the mid-to-high teens (against a trailing average of 13.1%), driving FCF growth about 100bp ahead of revenue growth.

Discounting those cash flows back, the shares look priced for better than a 10% long-term annualized return from today’s level. The shares also look undervalued on my margin-driven EV/revenue and EV/EBITDA approaches.

Valuations have retreated to the low end of the historical ranges for semiconductors (not surprising given sentiment), but if I take the low end of what the market has typically paid for the margins I expect from Cirrus in FY’24 (I’m using that because they’re lower than in FY’23), take a 20% haircut to that, and then use them on my 12-month revenue and EBITDA estimates, I get an averaged fair value of $88. In my mind, a 20% haircut to trough (or hopefully near-trough) multiples is sufficient acknowledgement/discounting of the Apple customer risk and other company and cycle risks.

The Bottom Line

I can understand the elevated headline risk here, and I can likewise understand why investors may choose to avoid a company that relies upon Apple for so much of its business (around 80%). That hasn’t worked out so well for many companies in the past, and even if management’s efforts to diversify are successful, they will take years to achieve.

Going back to my opening statement, it often pays to be suspicious when an investment looks to cheap. I think in the case of Cirrus, though, a lot can be tied to weak sentiment on smartphones over the next year and avoiding heavy Apple exposure. I think those are fair points, but I think the stock price already reflects that and arguably doesn’t give enough credit for management’s execution on growth and diversification strategies.