We all know that we live in a society where our lives and increasingly high standard of living are driven by rapid improvements in technology. However, it is rare that, as investors, we have the opportunity to hold positions in the leading businesses in this arena, unless we are willing to pay exorbitant multiples of most standard metrics in order to acquire the shares. As one who is only willing to buy what I believe to be substantially undervalued assets with enormous upside, created by widespread misperceptions in the broad market, this is simply not an arena where I normally allocate a great deal of capital. However, when existing shareholders are willing to give away future earnings of a solid business that is in the process of effectively dealing with potentially problematic issues, I am willing to look hard at the opportunity. I have found what I believe to be that exact situation with Cirrus Logic, Inc. (NASDAQ:CRUS) today; a leader in its industry, which is supplying high precision analog and digital signal processing components to the audio and energy industries.
As of the market close yesterday, the price to earnings (PE) ratio for the current year is approximately 7.5, based on the consensus estimate of $3.26/share for the year ending March 2013. With the consensus for 5-year annual earnings growth at 15%, this stock could easily support a stock price of $37 to $40 per share. But this one gets even better! The estimates for the current year (ending 3/13) and 2014 have been rising in the last 90 days!
Cirrus Logic has no long-term debt and only $138.95 million in total liabilities. Against this amount, the business is holding $148.17 million in cash and short-term investments, $170.68 million in receivables and $135.02 million in inventory! If you value the inventories and receivables at only 50%, the company covers ALL of its liabilities and still has $162 million dollars left over. Considering Apple Inc (NASDAQ:AAPL) accounts for 90% of the company’s sales, it is highly unlikely that they will not collect almost all of their receivables and sell the vast majority of their existing inventory………unless you believe Apple is about to go out of business. In a purely financial sense, this one is a rock! As they say in the infomercials: “BUT WAIT! THERE’S MORE!”
This is also a business that knows how to allocate its resources in a very efficient manner. Over the last five years, they have produced annualized returns on equity, assets and capital of 22.5%, 19.1% and 21.9% respectively! Those are exceptional numbers in today’s economic environment and they show that management doesn’t tolerate the waste of shareholder’s money and is very talented when it comes to generating attractive returns on that money. This is a trait I love to see and is much too difficult to find.
Its two main publicly traded competitors are Texas Instruments Incorporated (NASDAQ:TXN) and STMicroelectronics N.V. (ADR) (NYSE:STM) . Based upon the same metrics used above, the numbers for these two businesses respectively are: ROE: 20.06% & -4.02%, respectively; ROA: 14.3% & -5.6%, respectively; ROC: 16.9% & -7.3%, respectively. Cirrus compares very favorably with Texas Instruments on these metrics and they both are far superior to STM. Cirrus is also allocating substantial amount of their free cash flow to retire outstanding shares of stock. This practice quietly increases the value of the remaining shares, but is not something that typically shows up quickly in the stock price and creates opportunities for bargain hunters before the average investor catches on.
One last little thing about this business, they have maintained an average net profit margin of 23.8% over the last five years! How many businesses do you know have accomplished that feat in the economic environment we have seen since 2007.
Over the past year, the shares of Cirrus Logic have traded as high as $45.49 last September and as low as $20.28 last April. You will notice that the share price in this stock since September has acted much like the share price of Apple, its largest customer. The reason is, quite simply that Cirrus generates about 90% of its sales to Apple. First, I believe, as Mark Twain said about himself, that the rumors of Apple’s death are greatly exaggerated. Also, I don’t think the emotionally driven shareholders who have recently sold their positions really took the time to see if Cirrus’ management was taking any effective action to reduce their only hope for survival upon Apple’s continued business. They have and the initial results are encouraging as they are adding new customers.
Also, Apple’s business is not going away as Cirrus provides critical components for its products and is a top tier supplier that could not be easily replaced. The reduction of Apple’s percentage of Cirrus’ business will not come as a reduction of sales to Apple, it will come as a result of Cirrus aggressively and successfully marketing its products to new customers and expanding their overall sales. Once the average investor catches on, demand for these shares will rise and the price will return to a much more appropriate valuation based upon the real fundamentals of the business.
The article Don’t Miss the Incredible Return Potential of Cirrus Logic originally appeared on Fool.com and is written by Ken McGaha.
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