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Citigroup (C) is still slightly undervalued based on a
discounted cash flow model despite currently trading only slightly off its 52
week high and having risen 36.76% over the last twelve months. Citigroup is not unique in this regard. The other three giant U.S. banks JPMorgan
Chase (JPM), Wells Fargo (WFC), and Bank of America (BAC) have gone up 27.15%, 4.02%,
and 39.38% over the last 12 months, respectively. Wells Fargo was the notable underperformer
relative to peers largely due to the impact of the fake accounts scandal.
None of these banks are trading at a huge discount to fair
value after these impressive runs. Our
DCF model shows Citi, JPMorgan, Wells Fargo, and Bank of America trading at 92%,
95%, 98%, and 87% of fair value, respectively.
The DCF model considered a 10% discount rate, the earnings over the last
12 months, the current dividend, and the average long term growth rate from
analysts covering the companies.
Specifically, the inputs for Citi are listed below:
Dividend: $1.28 (Yield: 1.73%)
Long term earnings growth rate: 9.53%
Discount rate: 10%
Target Buy Price:$78.7 (92% of current price)
Citi is cheaper than JPMorgan and Wells Fargo and slightly
more expensive than Bank of America based on the DCF evaluation. However, there is good reason for this slight
undervaluation. Citigroup had the lowest
average annual growth rate over the last five years out of the four banks. Additionally, Citigroup ranks lowest based on
various profitability metrics. For
example, Citi has the lowest return on equity and profit margin among the big
four. The trailing twelve month profit
margin for Citi was 23.6% compared to 31.7%, 35%, and 46.6% for Bank of
America, Wells Fargo, and JPMogan, respectively.
We should also note that the average estimate for Citi’s
long term earnings growth rate of 9.53% from analysts polled by Reuters
seems rather optimistic. One should note
that the average annual growth rate of the last five years was 5.7%. On a positive note, that gives at least some
credibility to the growth rate used above, quarter over quarter earnings grew
by 14.5%. The latest 10Q shows EPS of
$1.42 for the three months ending September 30th compared to $1.24
for the same quarter in 2016. While
there is potential for Citi to achieve the 9%+ average annual EPS growth, especially
with its operations in Latin America and Asia, there is plenty of uncertainty
evidenced by the low end of the analyst estimates for the annual long term EPS
growth which came in at 5%. Using this
more conservative forecast in the DCF model actually results in a target buy
price that indicates that Citi is trading 15% above fair value.
Citigroup splits its results by three segments which include
Global Consumer Banking (GCB), Institutional Clients Group (ICG), and
Corporate/Other. The GCB Group includes
operations in North America, Latin America, and Asia offering local business
and commercial banking, residential real estate loans, and asset management in
Latin America. It offers Citi-branded
cards in all regions while offering retail services in North America. The ICG provides Investment banking and
treasury and trade solutions in addition to corporate lending. It also offers markets and securities
services in fixed income and equity markets.
This segment also generates some of its revenue from Europe, the Middle
East, and Africa (EMEA). Finally, the
Corporate and Other segment covers operations and technology and global staff
functions as well as other corporate expenses.
It also includes results of discontinued operations.
A review of the third
quarter operating results shows that the quarter over quarter jump in EPS
is largely attributable to the ICG which saw income increase by 15% quarter
over quarter. The ICG had net income
increase by 24%, 15%, -2%, and 11% in North America, EMEA, Latin America, and
Asia, respectively. The bright spot in GCB
was Asia. Net Income from GCB increased
by 15% in Asia while it actually declined by 16% in North America. Latin America’s GCB segment saw modest income
growth of 3% on a quarter over quarter basis.
Citigroup’s net income also got a boost by the reduced drag from
discontinued operations compared to 2016.
While you can do a lot worse than investing in Citigroup,
investors can likely find better places to put money at this point. Citigroup is now fairly valued even if you
use the more optimistic end of the long term growth estimates in your valuation
calculations. It also usually is not
advisable to invest in the least efficient or least profitable company just
because it seems cheaper. There are some
promising aspects of Citi’s business with its operations in Asia and Latin
America providing real growth potential.
However, recent results show that Citi continues to lag its three big
peers on most profitability and efficiency metrics.
Cirrus Logic has not kept pace with the rise of
the NASDAQ this year leaving it as one of the few value plays left in the
The company is poised to benefit from many of
the hot emerging areas in the technology space such as the smart home and
This company is well off its highs, has a strong
balance sheet, has impressive cash flow, and we still see significant growth
Cirrus Logic is one of the few technology companies with a long
term positive outlook that is not hovering at a 52 week or all time high. In fact despite the 5% jump on Friday, the
company is still 20% below its 52 week high and is only up 0.85% for the
year. We think the future for Cirrus Logic
is bright given the emerging opportunities for the portable audio chip
maker. Cirrus Logic has grown sales by
an annual average of 29.2% over the last five years. EPS grew by an annual average of 24.90% over
the same time period. If you believe
that Cirrus can grow earnings at even half this rate for next five years, like
we do, then the company is significantly undervalued at current levels. Added to the growth potential, Cirrus has a
strong balance sheet which includes no long term debt.
Cirrus Logic is a portable audio chipmaker. They are a leader in high performance
low-power integrated circuits for audio and voice signal processing
applications. The company’s products
cover every aspect of audio in electronics from capture to playback. Their components are found in smart phones,
tablets, digital headsets, and as will be discussed more below smart home
applications. If you have an Apple
iPhone, you are using Cirrus components.
Per the 2017
Annual Report, the company targets growing markets where it can leverage
its expertise in analog and digital signal processing to solve complex
The company basically operates in two segments which are
portable audio products and non-portable audio products. The portable audio products are used in
mobile applications such as smart phones and tablets while the non portable
audio products are used in smart home applications as well as automotive and
Cirrus contracts out the production of their semiconductors
so they are a fables semiconductor supplier.
We view this as a positive since it reduces capital expenditures. Additionally, the company says that the
outsourced manufacturing strategy allows it to concentrate on its design
strengths while minimizing fixed costs.
They use a variety of foundries including those of Taiwan Semiconductor
(TSM) and MagnaChip Semiconductor.
The company’s main competitors include Qualcomm, AAC
Technologies, AKM Semiconductor Inc, and Analog Devices Inc. to name a
few. Cirrus and its competitors have
more frequent opportunities to achieve wins in the portable audio device
segment due to the shorter product life cycles compared to non-portable audio
market which provides more reliable continued revenue streams.
One driving force we want to highlight is
voice-as-an-interface. Here we are
talking about human interaction with computers or other electronics through
speech in order to initiate a response.
One product that already highlights this as a growth area for Cirrus is
the Amazon Voice Capture Development Kit.
As stated by Jason Rhode, the Cirrus CEO, in the 2018 first quarter
call, the Voice Capture Development kit “enables a wide range of consumer OEMs
to bring Alexa-enabled smart home products to market faster and more
efficiently.” The Amazon Alexa Voice
Service adds voice control to connected products that have a microphone or
He went on to state that he expects voice-as-an-interface to
be a really huge driving force in the industry.
There are many opportunities for Cirrus in this emerging area. This was emphasized by Jason Rhode in the
conference call as he noted that where Cirrus really sees its strength is in
improving performance via algorithms embedded in a device to provide audio and
voice performance in ultra low power, low latency applications.
Our Answer to a Recent Underperform Rating
Customer concentration is by far the biggest concern for
Cirrus with the Apple (AAPL) iPhone accounting for somewhere between 75 to 80%
of revenue. A Bank of America analyst
recently issued an underperform
rating on the stock with a $50 price target largely related to this concern. The rational was that revenue from the iPhone
may not increase after fiscal 2018. We
think there are sufficient opportunities aside from the iPhone to allow for
continued growth. Again keep in mind
that the share price of Cirrus should increase substantially if the company can
just grow earnings by less than half the annual average of the last five
years. The company already counts many
other major companies as customers including Samsung, Lenovo, and Ford to name just
With emerging opportunities for their components to be used
in more products such as those related to biometrics and in applications using
voice as an interface, the company should be able to reduce the share of
revenue coming from Apple. At the very
least, we expect to see revenue from other companies increase going forward
even if Apple remains by far the largest customer. One other example of this was highlighted on
the 2018 Q1 call. The company mentioned
ramped production of a recently introduced hi-fi DAC and a boosted amplifier
with a customer in China for a flagship smart phone that was introduced in the
In order to justify the underperform rating mentioned a very
short term outlook is required. The
rating analysis mentions that significant revenue won’t be generated from
emerging opportunities such as Android smart phones and wearables for at least
two to three years. We do not view this
guidance as overly helpful to investors given that it rarely makes sense to
judge potential investments by placing emphasis on what is happening in the twelve
months or the next couple of quarters.
If you do not think a company has a positive long term outlook, you
would likely never consider investing in it to begin with. Similarly, if you think a company has a
bright long term future, how much emphasis would you place on the next quarter? Trying to time the market generally costs
more in missed opportunity than it saves.
We believe that companies as well as investors that focus more on narrow
short term results rather than long term value underperform.
Add to this that Cirrus is currently significantly
undervalued based on a discounted cash flow model as well as relative to its
peers. It seems that any temporary
slowdown in growth is already priced in.
This just makes it even more likely that the company can surprise to the
upside. Keep in mind that we are talking
about a company with a current P/E ratio of 13.33, a forward PE ratio of 11.88,
and an average long term EPS growth estimate of 20%. Finding overvalued technology companies
priced to perfection is actually very easy in the current elevated market
making a sell rating on a company with Cirrus’ valuation even more illogical.
Research and Development
The company spends a significant amount on R&D which is
required to keep up with the fast changing technology and continue to provide
innovative solutions to its clients. Per
the annual report, for fiscal 2017, 2016, and 2015 research and development
expenses totaled $303.7 million, $269.2 million, and $197.9 million,
respectively. The 2017 increase in
spending was largely attributed to the 16% increase in R&D headcount. The company now employs over 1,000
When an analyst asked about the lack of debt and potential
uses for the generated cash, the first part of the CEO’s reply was focused on
the continued investment in R&D as well as adding small technology
acquisitions over time. We think that
this approach makes sense given the number of growth opportunities that should
present themselves in the near term and coming years. Buybacks were also briefly mentioned as a
possibility as something that will be looked at on an opportunistic basis.
A big part of staying on the cutting edge and driving
innovation for technology companies is the ability to retain top engineering
talent. On this front, Cirrus was ranked
14th in the Forbes list of best
places to work for small and medium-sized technology companies. The company has a 3.8 out of 5 rating on Glassdoor. Overall, at a high level based on reviews and
ratings, it appears that Cirrus Logic provides an environment that allows it to
retain and hire the engineering talent required to drive innovation and grow
We will consider a discounted cash flow model with the
inputs provided below. For the long term
EPS growth rate, we will not use the average annual growth rate of the last
five years, 24.9%, or the overly optimistic average analyst estimate of
20%. Instead we will use half of the
average analyst estimate, 10% in addition to applying a 10% discount rate. The model will also not assume any share
buybacks even though a share repurchase program has been authorized. In the last few years the share count has actually
increased slightly every year. A future P/E of 15 is used in the model which is
higher than the current P/E of 13.33 but is lower than the average P/E of the
sector, 16.31. The model inputs are
Discount rate or desired annual return: 10%
EPS (ttm): $4.28
Average annual EPS growth rate estimate for the
next five years: 10%
Expected future P/E: 15
Using the inputs provided above, the DCF model tells us that
Cirrus is trading at 89% of fair value when using a 10% discount rate.
Another model we considered was even more conservative and
used a 10 year time period. In this
model we used the same 10% growth rate for the first five years and then
assumed that the growth rate would decline by one percent each year for the
remaining five years. Under this ultra
conservative scenario, the model finds that Cirrus is trading at 102% of fair
value. Given that this overly
pessimistic model still shows Cirrus Logic as fairly valued, we think the DCF
models confirm that Cirrus is a buy at current levels.
We mentioned previously that Cirrus Logic operates under a
model that is light on capital expenditures.
This has allowed for impressive cash flow. The table below shows that cash flow from
operations easily covered investments in property, plant and equipment. The table also shows the cost of acquisitions
in the last 10 years.
Looking at the income statement for the last 5 years, we see
impressive increases in sales. We see the
recent upward trend continuing, even if not at the same impressive rates as the
last couple of years, given the expanding opportunities for their components to
be used in a wider array of applications.
We think the 10% average annual increase in earnings used in our DCF
model above is achievable and has a relatively high probability of being
surpassed. Sales grew by 23.6% on a
quarter over quarter basis providing further indication that Cirrus is not
Other positives to keep in mind are the lack of long term
debt and the impressive current ratio of 4.0.
On a slightly more negative note, the balance sheet shows an accumulated
deficit. However, it is becoming less
negative at an impressive rate and should change to showing retained earnings
We think that Cirrus Logic underperforming the NASDAQ by
such a wide margin provides new investors with an opportunity to acquire the
shares at a fair or even discounted price.
This is based on the discounted cash flow model and the emerging
opportunities for the company to broaden its client base and the likely increase
in the number of applications for its components.
Cirrus Logic is one of the few value plays left in the
technology industry. We see this as an
interesting opportunity not only because of valuation but because it is a
growth story. Its audio components are
directly related to many hot growth areas such as the connected car, smart
home, and secure user identification or authentication. Yes, Apple is a big customer and we are
concerned about customer concentration.
However, the company does have about 3,000 customers world-wide and we
think the company can expand on these relationships to build its business with
them in these new emerging areas.
Although the company does not pay a dividend as a result of
the focus on growth, there is an opportunity for investors to obtain a yield
boost via options. We recommend looking
at the possibility of using a buy-write strategy. One example would be to sell the call
expiring on March 16th with a strike price of $75. The seller receives $55 per contract sold or
$0.55 per share based on the current bid.
This equates to an annualized return of over 2%. Note, that in this case the investor would
only need to sell his or her shares if the stock price increased by over 31%
from the current price of $57.02 in slightly over four and a half months.
Finally, for investors that are adverse to buying something
that just went up over five percent in a single day, we understand but suggest
keeping Cirrus Logic on the radar with the possibility of taking advantage of
any pullbacks. For investors that
consider valuation, looking to put some money to work in the technology sector,
we think Cirrus is a logical choice that will provide satisfactory returns in
the years to come.
Ichor share price does not make much sense after
performing a discounted cash flow analysis.
The company is producing some of the most
complex subsystems needed by semiconductor manufacturers.
The stock has already soared this year but we
think substantial upside potential remains.
Ichor Holdings (ICHR) has gone up well over 100% for the
year. Despite this the stock still
appears grossly undervalued even if we assume little growth. In reality growth expectations are not low at
all for this semiconductor equipment company.
Recommending stocks after such a strong rally is not generally something
we would consider but Ichor’s current valuation, to be discussed below, makes
us confident that this is still an attractive opportunity for new
Ichor is a $658 million dollar company involved in the
design and manufacturing of fluid delivery systems for equipment used in
semiconductor manufacturing. The main
products include gas and chemical delivery subsystems which are key components
of tools used in the manufacturing of semiconductors. The gas delivery subsystems deliver, monitor,
and control precise quantities of specialized gases used in semiconductor
manufacturing processes such as etch and disposition. The chemical delivery subsystems blend and
dispense the reactive liquid chemistries used in semiconductor manufacturing
processes such as chemical-mechanical planarization, electroplating, and
cleaning. Finally, the company also
manufactures components for use in fluid delivery systems.
Most semiconductor OEMs outsource the design and manufacture
of their gas delivery subsystems to a few specialized suppliers such as
Ichor. Increasingly OEMs are also
outsourcing the design and engineering of chemical delivery subsystems as a
result of the increased fluid expertise required. Ichor will continue to benefit as this
outsourcing trend continues. The OEMs
benefit by outsourcing the work related to these fluid delivery systems if it
allows them to reduce the fixed costs and development time. In its latest
10K, Ichor says its clients include two of the largest manufacturers of
semiconductor capital equipment in the world, Lam Research (LCRX) and Applied
Materials (AMAT). The company frequently
has its engineers working at its customer’s sites to engage with their product
design teams. This allows the company to
build subsystems to meet the exact specifications of the customer and often
allows them to be the sole supplier of these subsystems during initial
production ramp up.
Ichor has a 17 year history in which it developed deep
capabilities in designing and building gas delivery systems. The company has a global footprint with
facilities located close to its customers.
This has allowed the company to establish long standing
relationships. Over two decades, the company
has been developing complex fluid delivery subsystems to meet the constantly
changing production requirements of semiconductor OEMs. They have significant capacity in Singapore
to support high volume products. The two
companies mentioned previously, Lam Research and Applied Materials, were the
two largest customers by sales in 2016. Sales
from continuing operations grew by an impressive 40% to $405.7 million in 2016
with net income coming in at $20.8 million.
Ichor’s engineering team is made up of chemical, mechanical,
software, and systems engineers. Their
engineering teams work directly with their customers’ product development teams
to provide technical expertise outside their core competencies. The company seeks to use its long standing
relationships with two of the market leaders to locate new business
opportunities created as a result of industry consolidation. The assembly and integration of high purity gas
and chemical delivery systems happens at the company’s locations in Singapore,
Tualatin, Oregon, and Austin, Texas. The
company also has a facility in Malaysia for components used in the gas delivery
subsystems and in Union City, California for components using in chemical
delivery subsystems. These facilities
are located in close proximity to customers.
One of the key elements that make Ichor an attractive
investment is the relatively low rate of capital expenditure. The company is able to grow sales with a low
investment in property, plant and equipment.
The company also highlights its close supplier relationships which allow
it to scale up production quickly without maintaining a lot of excess
inventory. Risk is reduced by this low
fixed cost approach since it minimizes the impact of cyclical downturns on net
income. We prefer this conservative
approach even though it results in a smaller increase in gross margin as a
percentage of sales in times of increased demand.
The company acquired Ajax United Patterns and Molds in April
of 2016. This acquisition is what
allowed Ichor to offer chemical delivery subsystem capabilities to its existing
customers. The Ajax acquisition enabled
Ichor to manufacture complex plastic and metal products required by the
medical, biomedical, semiconductor, and data communication equipment
industries. As a result of deploying
more leading edge tools, the company will grow its business as OEMs will need to
refurbish legacy systems.
More recently the company acquired Cal Weld, a leader in
metal component manufacturing which is considered a strategic business for
Ichor. The acquisition cost was $50
million of which $20 million was paid in cash and the rest borrowed. It expands capacity and capabilities in the
component manufacturing area for gas delivery tools in semiconductor
manufacturing. Cal Weld supports key
semiconductor tools such as deposition and etch. The Cal-Weld facilities are located in
Fremont, California and Tualatin, Oregon.
Cal Weld is expected to generate between $65 million to $80 million in
revenue next year.
While there is currently a risk posed by customer
concentration, the company is seeking to expand its customer base within the
fluid delivery market. The recent annual
report mentions that Ichor was selected as a manufacturing partner for a
provider of etch process equipment that was previously not a customer. The company is also planning to diversify its
sales exposure and leverage its current capabilities by acquiring new products
and solutions for high growth applications in new markets such as medical,
research, and energy.
In the second quarter earnings call the company sounded very
optimistic on continued growth noting that they are seeing increased business
beyond the two largest customers. The company
said its third and fourth largest customers are expected to grow 100% this
fiscal year. One of these customers asked Ichor to redesign their gas delivery
systems for better performance and lower cost.
Clearly one concern for Ichor is that the semiconductor
equipment OEMs could start developing the gas or chemical delivery subsystems
internally. Otherwise, the primary
competitor is Ultra Clean Technology for gas delivery subsystems. The chemical delivery subsystem industry is
highly fragmented as is the tool refurbishment market.
As a result of the customer concentration issue mentioned
previously, the clients have a significant amount of negotiating leverage which
could lead to price and margin pressure.
Additionally, the company will be impacted by any decline in
semiconductor sales or the various electronic products requiring
One more unique concern is the fact that Ichor is a largely controlled
by a single investor, Francisco Partners, which owned over 74% of the
outstanding shares at the time of the last annual report. This is a board governance issue since it
means that Francisco basically controls who is elected to the board of
directors which could mean that the interests are not always aligned with the
interests of other shareholders.
Also, keep in mind is that the company is incorporated in
the Cayman Islands and Cayman Islands law provides less protection for
shareholder interests compare to the laws of the United States. Another drawback that comes along with
investing in a company that only recently became public is that there is not the
same level of historical data available as compared with companies that have
been public for an extended period. The
company provides financial statements going back to 2014 which will be
discussed in sections that follow.
Financials & Valuation
The balance sheet is
not ideal given that retained earnings, or in this case accumulated deficit,
are negative and there is some long term debt even if it is not an unreasonable
amount. While there is currently still
an accumulated deficit the value will not be negative for long if the current
pace continues as seen in the table below.
The current ratio comes in at an acceptable 1.80 and long
term debt to equity stands at 0.22. A
clear positive is seen when looking at the income statement where we see
incredible sales growth in the last three years as well as the last few
quarters. We also like the way the annual
cash flow numbers are looking where cash flow from operations easily covers
capital expenditures and even the 2016 acquisition.
Looking more closely at recent results, it should be noted
that we are seeing some margin pressures.
For the quarter ending in June, although sales increased, net income
actually decreased as a result of increases in the cost of goods sold and
operating expenses. The table below
shows cost of goods sold and operating expenses as a percentage of revenues. One part of the drop in income not shown in
the table is the negative contribution of -$610,000 from discontinued
Next, we will take a quick look at our discounted cash flow
model. Rather than use the trailing
twelve month EPS of $3.64, we will use the lower EPS estimate for next year
which is $2.79. We rather use the lower
of the two numbers to keep the model slightly more conservative. The current forward P/E is 9.46. We think this is unreasonably low in
comparison to the industry and market in general and will use a future P/E
ratio of 15 in the model. Finviz provides an optimistic long term EPS estimate
of 29.25%. Earnings did grow by 310% on
a quarter over quarter basis. Keep in
mind that this is at least partially related to the acquisitions mentioned
above. We will not use either of these growth
numbers in our DCF model. Instead we
will adjust the required long term growth rate until the model shows that the
current price is equal to the target buy price.
In this way, we see the growth rate that would be required to get the
return on investment we are looking for.
The DCF model inputs are summarized below:
·EPS estimate for next year: $2.79
·Future P/E ratio: 15
·Discount rate (desired annual return): 10%
·Long term annual EPS growth rate: 1%
(Read notes below)
Again, the long term EPS growth rate used above is not what
we actually expect the growth rate to be.
This is just the calculated growth rate required to make the current
price equal to our target buy price.
Basically, the model is showing us that the stock is grossly undervalued
if one actually believes the analyst estimates or assumes any kind of
substantial growth from here like we do.
Despite the massive run up since the IPO, the DCF model makes us think
there is still plenty of room to the upside.
The table below provides some key valuation and financial metrics for
Clearly the right thing to do was buy the shares at the IPO
price or anytime at the beginning of the year since the stock has already gone
up well over 100% for the year. However,
this does not mean it is too late to initiate a position. In the case of Ichor, we think there is still
plenty of room to the upside from here based on the discounted cash flow model
and growth prospects. We rate Ichor a
buy. Unfortunately, a buy-write strategy
is not a possibility since there are no options available for this stock. Of course, we do not think this is a reason
to ignore Ichor given the significant undervaluation. The potential of this small cap company, with
a market cap of $661.83 million, appears to be going unrecognized by the market
and it may make sense to buy before it starts getting the attention it
deserves. Finally, keep in mind that other
companies in the space like Ultra Clean Holdings (UCTT) trade at much higher