Cirrus Logic- Nailed to Apple’s Cross?

Cirrus Logic
Cirrus Logic

This is a checklist I use to quickly come to a conclusion on a stock.  I score a stock, each line getting a 1, 0, or -1.  A stock  that scored 1 on each line would be a perfect 10.  Buy it!

Some of these items are quite subjective.  For example how would I score Cash Flow?  If a company’s cash flow is much lower than it’s reported earnings, that raises a flag and I would score it a -1.  If there are more insiders buying than selling, I would score it a 1.  If there are no apparent catalysts in the near future I would score it a 0 but on the other hand if there is a pending secondary that will put more stock out on the market, I would score it -1.

  1. CHART- know how to read charts. I firmly believe I can improve the price of buying or selling from an understanding of chart action.  A good chart gets a 1, a bad one, -1 and inconclusive is 0 RSI is diverging in a bullish manner.  Cirrus also looks like it could be building a painfully slow base before it improves +1
  2. ANALYSTS- read analyst reports but come to your own conclusions.  If the consensus is favorable, 1; if unfavorable -1, and mixed 0. Cirrus is not widely followed.  There are 2 strong buys, 1 buy,   holds.  The following is a press release from Standard & Poor’s:       — U.S. fabless semiconductor provider Cirrus Logic maintains steady operating performance and strong credit statistics relative to its rating level.      — We are raising our corporate credit rating on Cirrus to ‘B+’ from ‘B’.      — The stable rating outlook reflects our expectation that Cirrus will continue to generate good profitability and maintain low leverage through the end of 2011.  Plus 1
  3. INSIDERS- if the people who know the company the best are not buying it, why should you? This one gets a positive mention  since a director who was the CFO of Novellus, an important semiconductor company  recently bought 142,000 shares at $21.06, a price much much higher than where it trades now. prices close to where it is trading now.  plus 1
  4. MANAGEMENT DISCUSSION 10Q AND 10K- this is the only truthful thing you will read about a company. It’s composed by management, the auditors, and the firm’s lawyers.  If all three of them can agree on the verbiage, it’s passed a big hurdle.  Read it carefully.  Pay particular attention to the Risks, Litigation, and Related Transaction sections.  These are the things you will wish you had taken the time to read if something goes bad with your investment. The company has nearly half of its business coming from Apple and recently suffered a design setback which they claim they have corrected without disruption to the customer.  They also have one customer, Futaihua Industrial (sister company of FoxConn and Apple major contractor)which represented 42% of trade receivables.   The company also has $423.7 million in NOL carryforward.  They wont’ be paying taxes for a long time to come.   The company purchased stock and has canceled those shares.  From 10-K: “The Company has made additional repurchases under the previously announced $80 million stock repurchase program. For the period March 27, 2011 through May 24, 2011, the Company has repurchased and retired approximately 3.5 million shares of Cirrus common stock at a cost of approximately $55.3 million.” Sales grew 67% in 2011 from 2010 but the Company anticipates less than 15% growth in the first two quarters of 2012 which would be the quarter ending June and the one ending Sept.  That probably explains weakness in the stock.  I give this a -1 because of concentration of risk
  5. MARKET DIRECTION- 80% of stocks follow market direction in the short-term.  This is your read on the market.  Don’t have an opinion, it’s a 0. Market is near term oversold but I’m not decisive here. Give it a 0
  6. SECTOR OUTLOOK- buying a good stock in a bad sector can be a humbling experience. CRUS is a small cap semiconductor company. YTD semiconductor sector is up 6.74% but down 5.15% in the last three months.  Give this a 0
  7. CASH FLOW- cash flow is more accurate than earnings. Earnings can be more easily manipulated. Cash flow rose dramatically year over year, more than three times.  Income from operations was almost identical to net cash provided by operating activities. I give this a 1
  8. PEG RATIO- it’s good to find a company growing faster than it’s multiple. Next quarter’s Peg Ratio is estimated at 1.10   This is close enough to 1 to give this a 0
  9. VALUATION- contrary to popular opinion, valuation does matter.   Use a discounted cash flow analysis.  If the stock is trading for substantially less than its DCF, that’s a 1. According to inputs from Valuepro  intrinsic stock value is $28.18 when you assume normalized net operating margins of 15% and 20% growth rate.  If you reverse the inputs and assume 15% growth and 20% operating margins ISV is about $26.97.  Cirrus is undervalued and we give it a + 1
  10. CATALYST- what’s going to change the status quo? My guess is they have a new hit product going into one of Apple’s products.  See Cirrus Wins iPad 2 Audio Codec Slot from Chip Works
  1. In addition since everyone is copying Apple, they have a good chance of picking up another major customer.  If they should lose Apple, stock will drop to single digits.   +1

Conclusion: Cirrus Logic is an oustanding value if you believe they can continue to ride the giant wave Apple is creating.  A clean balance sheet, no debt, huge NOL carryover, tax advantaged deferred assets, and broad IP make Cirrus also an outstanding private equity candidate.  Given their concentration of risk with one large vendor, I can’ score it any higher than 5 though.  Large companies like Apple will never be dependent on one supplier if they can avoid it.   I believe if Cirrus could lessen their dependence on one customer either through an acquisition or Apple competitor wins in the mobile market, their multiple would rise appreciably. We’ll post more on this company.  We really like it for the longer term which is rare for us.

Trading the markets is a humbling experience. I hope this handy checklist makes it less so.

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