Improving Product Mix Drives TI’s Growth In Q1’14

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Texas Instruments

Texas Instruments (NASDAQ:TXN) started its fiscal 2014 on a strong note as revenue from its legacy wireless business almost phased out. At $2.98 billion, TI’s revenue grew 3.4% year over year and was in the upper half of its expected range. Excluding wireless revenue (which declined to a single-digit million dollars) the company’s revenue increased by 11% year over year, led by a double-digit growth in both the analog and embedded divisions. Additionally, on account of an improved product portfolio, higher factory utilization and increased efficiency of manufacturing operations, TI’s gross profit improved by 6.2% and operating profit by 75% compared to Q1 2013.

Though TI’s restructuring initiative is almost over, the company claims that it will continue to monitor its investments and the market opportunities they address, to focus on those that have the best potential for sustainable growth and returns. The company will eliminate about 1,100 jobs this year. It plans to reduce its resources in Japan and estimates the above actions will result in annualized savings of about $130 million by the end of 2014.

Increasing revenue contribution from the profitable analog and embedded divisions, a robust product portfolio, one of the best sales and field application teams in the industry and strong manufacturing capacity will help spur TI’s growth in the future.

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We are in the process of updating our valuation for TI.

See our complete analysis of Texas Instruments here

Increasing Focus On The Embedded & Analog Portfolio Drives Growth

After its planned exit from the smartphone and tablet market in September 2012, TI has been focusing on transitioning its operations to become a pure analog and embedded processing company, segments that it believes will offer long term growth and less volatility, compared to the past. It derived 84% of its revenue from these segments in Q1 2014 compared to approximately 72% in the quarter ended September 2012. Combined revenue for the two divisions grew by 13% year over year in Q1 2014. TI believes that the analog and embedded processor market will keep growing, as important markets such as industrial and automotive continue to embrace electronic technology.

TI’s analog revenue increased 11% year over year in Q1 2014, primarily led by strong growth in power management and high performance analog (though all its major product lines grew in the quarter). The company accounts for 18% of the analog market and it expects to gain additional market share in 2014. Since 2006, TI has increased its R&D investments in the sector by 77%, resulting in steady increases in market share over the years.

With the acquisition of National Semiconductor, a strengthening product portfolio and growth in differentiated volume analog and logic segments, we believe that TI is well equipped to leverage increasing demand for analog products.

TI’s embedded processing revenue grew 17% year over year on account of strong demand for microcontrollers. With increased investments in this growth area over the past few years and new product launches, TI continues to expand its embedded portfolio every quarter. It believes that the embedded markets (currently sized at $19 billion) offer greater potential for sustainable growth.

TI plans to reduce investment in certain embedded processing product lines that either have matured or do not offer the return opportunities it is looking for. The company has clarified that is does not plan to exit any market or discontinue any existing embedded products, but is simply realigning its resources to better cater to market opportunities. It expects the ongoing changes to improve the profit margin in embedded business while still maintaining its pace of growth.

Improving Revenue Mix To Increase Gross Margin

Lower revenue, increased capacity under-utilization charges and the acquisition of its large analog competitor, National Semiconductor, impaired TI’s gross profitability in the last few years. TI’s gross margins declined from 53.6% in 2010 to 49.7% in 2012. However, higher revenues, combined with an improving product mix and better factory utilization, increased TI’s gross margin to 52.1% in 2013. In Q1 2014, gross margin further improved to 53.9%. (These are company reported GAAP gross profits)

The quality of TI’s portfolio has improved as the company derives a larger proportion of its revenue from higher value analog and embedded processing products, which are more profitable and less capital intensive compared to wireless products. Increased loading in its most advanced factories and shutting down of older, less efficient factories (such as the Houston and Hiji 6-inch factories) is an important factor which improved TI’s factory utilization, in turn improving margins.

At present, TI’s depreciation is $459 million ahead of its capital expenditures. The company expects its capital expenditure to remain at low levels (4% of revenue) for the next few years. As depreciation starts to work itself down over the next couple of years, it will boost gross margins.

We believe that TI can manage to retain its margins at the current level until 2020.

Q2 2014 Outlook

– Revenue in the range of $3.14 billion to $3.40 billion. At the middle of the target range, revenue would increase 7% year over year.

– Earnings per share to be in the range of $0.55 to $0.63.

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