The Trend

Key Suppliers of Apple Inc. (NASDAQ: AAPL)



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As the most highly valued public company in the world, Apple Inc. (NASDAQ: AAPL) is perpetually under a level of scrutiny that a lot of small and mid-cap companies can escape. And one of its scrutinized items has recently been the ethical treatment of workers outside of its own company, within its vast supply chain.

To be more attentive to how workers – even those tangentially involved in the making of Apple products – are treated, Apple took steps toward greater transparency in terms of its supply partners in 2012. Taking a similar approach to other large-cap companies like Nike and HP, an annual list of Apple’s top two-hundred suppliers is now published along with audit results of working conditions and manufacturing impacts on the environment.

While those who are socially conscious approved the publishing of the list, investors and traders instantly dug through it to develop new, better ways to trade APPL shares.

For example, French banking giant, Société Générale, published a trading strategy which focused on Apple’s publically owned Asia-based suppliers and it outperformed long positions of AAPL alone. The strategy was based on buying a basket of the both the top five best performing Apple Asian suppliers since the launch of the iPhone 5 and the five worst performers over that same time period. However, widespread acceptance of the strategy has likely been blighted by the fact that the basket of stocks underperformed key benchmarks despite returning more than AAPL.

IMAGE: Apple Supplier List has been Treasure Trove for Investors

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For US investors, a more practical strategy may be to ‘stock pick’ those Apple suppliers that are easier to trade domestically and have more than a trivial revenue exposure to the tech giant.

Table: US-Based Companies with High Customer Concentrations to Apple

  Revenue Exposure to Apple
Symbol Company Name Country 2012 2013 2014
ADNC Audience, Inc. US 46.0% 21.0% 8.0%
CRUS Cirrus Logic, Inc. US 62.0% 82.0% 80.0%
GLUU Glu Mobile Inc. US 56.0% 59.6% 61.8%
JBL Jabil Circuit US 14.0% 20.0% 18.0%
KN Knowles Corp. US 18.0% 25.0% 20.0%
MFLX Multi-Fineline Electronix US 74.0% 75.0% 57.0%
SNDK SanDisk Corporation US 13.0% 20.0% 19.0%
TTMI TTM Technologies US 21.0%

Source: company filings

Audience, Inc. (NASDAQ:ADNC) is a surprising stock amongst this domestic supplier group. At $110 million in market value and an average daily trading volume of about 150,000 shares, ADNC is a very small company – especially for an Apple supplier. And ADNC would typically struggle to be noticed by analysts outside the odd small regional brokerage firm with an equally small research department – which is basically what they’ve got with four of the five firms that currently cover it. However, there is one outlier in the form of Deutsche Bank who initiated coverage on ADNC shares back in the summer of 2012. DB might have done this for investment banking reasons or to get greater color on its coverage of AAPL. Or maybe both.

But DB currently has a Hold rating on ADNC shares, and part of the reason might be shown in the table above. Audience’s Apple customer concentration has been dropping as the tech giant is not using its chips in newer iPhones. (However, Samsung is increasing their use of Audience products and represented 75% of ADNC revenues in 2014.)

With 80% of its FY14 sales coming from Apple, one might assume that Cirrus Logic Inc. (NASDAQ:CRUS)’s performance is correlated highly with the Cupertino company. In fact, this year so far, CRUS shares have performed nearly four times better than AAPL’s with a holding-period return of 39% compared to 12%.

Cirrus Logic Outperforms Apple Shares Year-to-Date in 2015

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Source: BigCharts.com

The last three analyst upgrades of CRUS shares were all upgrades and there is still about 8% upside from current levels to the street’s average price target of $35.13. Trading at 20.4x forward earnings.

Glu Mobile, Inc. (NASDAQ:GLUU) is another small-cap name, but this one is focused on the software side of the Apple iPhone scene. Glu’s biggest claim to fame, a mobile game based on Kim Kardashian, is sold exclusively online through distribution networks including Apple iTunes, Google Play and Amazon’s Appstore. Last year, Glu turned the corner to being free cash flow positive, and its shares are trading well off 52-week highs. Investors might find this a timely trade, although we think the company is increasingly overexposing itself to Hollywood brands that a fickle public could turn its collective back on with little notice…

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Right now, SanDisk Corp. (NASDAQ:SNDK) is trading about 33% below the consensus analyst price target, so it has some foreseeable upside, which is in relative contrast to AAPL which are more fully valued with only 13.8% upside to its average target price remaining right now.

We like SNDK’s forward earnings multiple which is roughly half of the broader market right now (10.4x vs. 18.5x for the S&P 500). We also like its price-to-cash flow multiple at 9.1x compared to its own five-year average of 14.8x. Perhaps most compelling is that SNDK is teetering on making the turn from generating returns on invested capital (ROIC) below its weighted average cost of capital, to generating returns above it. Now depending on how you calculate ROIC, they may have already made that turn, but it’s too close to call and current valuation metrics do not appear like the market is recognizing that achievement.

Knowles Corporation (NYSE:KN), on the other hand, is one that might be considered more a speculative trade. A maker of cell phone microelectromechanical system (MEMS) microphone chips for OEMs Apple and Samsung, Knowles reported a disastrous 4Q14 on February 12 due in large part to:

“Revenue in our mobile consumer segment was down 6 percent sequentially, as microphone shipments on a specific platform remained on hold for the entire fourth quarter…”

Subsequently the stock traded down about 13% the next day and is now languishing in the low $19 range – far from 52-week highs of $33.82.

Knowles is considered a ‘speculative’ trade because it doesn’t have a lot of fundamentals in its favor at the moment. Revenue has dropped year over year and margins have been decimated. Free cash flow has been dropping – now into negative territory. Unsurprisingly, return on invested capital is also negative so the company is not creating economic value right now. It’s saddled with nearly $400 million in long-term debt that it has vowed to pay down. However, if it gets past its near-term microphone shipment problems, mobile handset adoption rates still favor Knowles and the fact that more than half of its revenue comes from product sales to mobile device manufactures. Other parts of its business, notably hearing aids, not only bring in a significant percentage of total revenue, but Knowles has very few competitors to deal with in that space.

At 8.6x forward earnings, KN might be an Apple supplier play worth taking a chance on.

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