Texas Instruments’ (NASDAQ:TXN) exit from the wireless market last year along with poor demand on account of low inventory level at OEMs and distribution channels led to a 12% sequential and 13% annual decline in its Q4 2012 earnings. With the extra manufacturing capacity added by the company over the years, the lower demand increased its underutilization expense by more than 50% in the quarter.
With a 16% sequential decline in orders last quarter along with a lack of visibility in business trends this quarter, TI anticipates lower revenue for Q1 2013 as well. However, though TI’s wireless revenues will continue declining, we believe that with increasing strength in its core business of analog semiconductors and focus on embedded processors, the company can witness a revival in its business 2013 onward.
Though the idle manufacturing capacity might weigh down TI’s bottom-line in the short term, it can leverage the same to meet higher demand in the future. Additionally, judging by the marginal decrease in TI’s operating expenses in Q4, excluding the restructuring charges, we feel that the company has been executing its operations fairly well in what is clearly a tough working environment.
Higher Revenue Contribution From Analog And Embedded Processors
Generating strong cash flow and investment returns, the analog and embedded processor divisions remain the focus areas for TI. While the wireless division posted an operating loss, both analog and embedded division made healthy profits. Revenues from the analog division increased by 10% though the embedded processing revenue declined by 7% in 2012 compared to 2011.
Higher revenue from National Semiconductors and growth in high volume analog and logic as well as power management contributed to higher revenue from the analog division. Despite growth in automotive and catalog products, the lower revenue from communication infrastructure applications contributed to the decline in TI’s embedded portfolio. We believe the slowdown in these business segments were more on account of macro factors and expect both these divisions to be TI’s primary growth engines in the future.
TI witnessed a strengthening product portfolio this quarter as the company earned a higher proportion of its revenue from analog and embedded processing products. The two divisions together contributed around 70% to TI’s 2012 revenue compared to just 47% five years ago.
With new product launches, TI continues to expand its analog and embedded portfolio every quarter. While the excess manufacturing capacity gathered over the years might weigh on its short term growth, we feel the same will help TI further increase its market share in the analog division in the future.
Increase In Gross Margins
Texas Instruments has added around $7 billion worth of incremental revenue generating capacity in the last few years with the acquisition of National Semiconductor and some other companies’ fabrication and equipment and factories. Amid a slowdown in the semiconductor industry, the additional manufacturing capacity has led to lower factory loading which has increased TI’s underutilization charges.
At 48.5%, TI’s gross margins declined slightly compared to last quarter mostly on account lower revenue and non-recurrence of $60 million in business interruption proceeds associated with the Japan earthquake. If we adjust for the acquisition-related charge and underutilization expense, gross margins in 2012 increased by 2.7% as compared to 2011.
At the start of 2012, TI announced its decision to close down two old factories in Japan and Texas by the second half of 2013. The company claims that it has no plans to take any more capacity offline and targets capital spending at historically low levels in the future. Additionally, it aims to keep its operating expenses in check in light of the lower revenue guidance for this quarter.
As TI derives an increasing proportion of its revenue from high-quality analog and embedded processing products and lower revenue from the less profitable wireless products, we expect its gross margins to increase marginally over our review period.
Outlook For Q1 2013
- Revenue in the range of $2.69 billion to $2.91 billion
- Wireless revenue to decline by $179 million
- EPS in the range of $0.24 to $0.32
- Discrete direct tax benefit of $65 million
We are in the process of updating our price estimate of $35.72 for TI