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Small Cap Could Deliver Triple-Digit Returns if Apple Rebounds This Summer

David Sterman

Shares of small-cap audio chipmaker Cirrus Logic (CRUS) have been in a freefall for the past six months, in tandem with the hefty pullback in Apple (AAPL). It's no coincidence, as Apple accounts for most of Cirrus' sales, and as Apple's release of new products slowed to a crawl, Cirrus has seen its own sales take a hit.

CRUS Stock Chart

In fact, Cirrus' shares had fallen more than 15% by midday trading on Wednesday, to a fresh 52-week low, after Cirrus conceded that Apple's dearth of new products would lead to worse-than-expected results in its fiscal first quarter that ends in June.

How bad will the June quarter be? Cirrus now expects to generate sales in the $150 million to $170 million range in the quarter. Analysts had been expecting sales of around $195 million. And per-share profit in the quarter is now forecasted to be less than $0.50, well below the $0.75 consensus forecast.

Yet, this seemingly bleak situation actually provides an opening for contrarian investors. Note that Cirrus simply issued guidance for the current quarter in a press release, but will actually discuss the outlook for subsequent quarters in a conference call to be held with investors on April 25.

What will management say on that conference call? We can anticipate a few topics:

First, Cirrus will likely discuss its efforts to diversify its customer base beyond Apple. The company has made major investments in both R&D and sales, and hinted on the last quarter's conference call that it is inching closer to key design wins with other customers.

Design wins typically translate into revenue growth two to three quarters later. Investors have been penalizing Cirrus for its overwhelming dependency on Apple, which is why shares trade for a single-digit earnings multiple. Broadening the customer base should help lift the multiple.

Second, Cirrus may (or may not) discuss its outlook for Apple-related sales. And this is the key reason to focus on this stock now. Although Apple is likely to be fairly quiet in the current quarter in terms of new product releases, the subsequent quarter should be much more active, perhaps including a new version of the iPhone and an iPad Mini with retina display.

If Cirrus can make a case for a solid quarterly rebound in its fiscal second quarter (ending in September) on its April 25 conference call, then shares could quickly move back into the mid-$20s as investors look ahead to an upturn.

Yet, even if investors take a wait-and-see approach later in April, the coming months could prove to be much more helpful to this stock. That's because the drum beat of news ahead of Apple's product launches will grow louder, and as that happens, investors will seek out corollary plays to an Apple rebound. And Cirrus is perhaps the highest-beta play on Apple around.

Analyst Bobby Burleson, who follows Cirrus for research firm Cannacord Genuity, sums it up best: "We expect strong design win share for CRUS at Apple, combined with constructive gross margin commentary for the June quarter (rebounding back to 50%-52% range) to support the shares ahead of Apple's product refreshes this summer."

Burleson sees shares rebounding to $25, though they may move even higher if Cirrus delivers both solid September quarter guidance (either on April 25, or in July, when the next guidance is issued) and announces new customer design wins outside of the Apple relationship. However, if Cirrus is unable to issue inspiring guidance, shares could drift into the mid-teens.

I think Cirrus will deliver, and $25 is a good conservative target for the small-cap stock. More aggressive investors could consider buying call options to leverage this move into triple-digit profits.

Recommended Trade Setups:

-- Buy CRUS up to $20.50
-- Set stop-loss at $16.50
-- Set initial price target at $25 for a potential 22% gain in four months

-- Buy CRUS Sept 20 Calls for $2.50 or less
-- Do not use a stop-loss
-- Set initial price target at $5 for a potential 100% gain in five months

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