Texas Instruments (NYSE:TXN) reported a weak first quarter but expects its results to have bottomed out and foresees a recovery hereon. Despite witnessing a decline in its overall revenues in 2011, the company managed to retain its position as one of the top four semiconductor vendors (in terms of revenue), with a 3.8% market share.  TI designs and manufactures semiconductors and competes with companies such as Qualcomm (NASDAQ:QCOM), Broadcom (NASDAQ:BRCM), Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC).
In the past couple of years, with the acquisition of National Semiconductor and the acquisition of some other companies’ fabrications and equipment and factories, the company added around $7 billion worth of incremental revenue generating capacity. However, if the industry demand does not pick up as expected, this additional capacity could come back to bite TI with increased costs, which could in turn affect margins.
Increased Order Backlog
Texas Instrument claims that the end of Q1 saw early signs of recovery as its orders went up by 13% and it is witnessing an increase in backlog. The management believes that inventory depletion has run its course in markets such as auto, industrial and infrastructure and that demand should pick up as the year goes on. According to research firm IDC, the global semiconductor revenue is expected to rise 6-7% this year. 
We believe that the Analog semiconductor segment, which contributes around 55% to TI’s price estimate, will see a 3% rise in the current year and will reach almost 60 million by the end of our forecast period. We could see a 7% upside to our price estimate if the industry size at the end of the period is 15% higher than what we forecast.
Better Factory Utilization to Increase Margins
TI’s ability to maintain or improve profit margins depends on its ability to utilize its manufacturing facilities efficiently so as to cover its fixed operating costs in an intensely competitive and cyclical industry. Q1 saw a sequential increase in gross margins at 49%, but a y-o-y decline of 2%, mainly on account of low levels of factory utilization. However, the company expects that as the production is factories start up more from Q1 onward, higher utilization benefits should come early in the second quarter. We estimate the gross margin to be around 51% in 2012, a marginal increase from last fiscal.
With all the capacity that TI has added, it’s quite important for the company to make the most of it and increase utilization levels, or else, the consequent higher fixed labor costs could have a negative impact, if growth doesn’t materialize. On the other hand, if chips go into another strong bull cycle, TI’s additional capacity and margin advantages could make the company shine. We do believe that the industry will see a revival in the current year, and hence maintain our price estimate at $45.29, a premium of almost 40% to the current market price.Notes:
- Worldwide Semiconductor Revenue Reached $307 Billion in 2011, Gartner Press Release, April 17, 2012 [↩]
- Worldwide Chip Sales May Grow at Faster Pace, IDC Says, Bloomberg, April 30, 2012 [↩]