Improving Revenue Mix Benefits TI’s Top & Bottom Line In Q2’14

Texas Instruments (NASDAQ:TXN), which designs and manufactures semiconductors, reported another quarter of strong growth in Q2 2014. On account of the diminishing revenue base from its legacy wireless business (TI exited this business in September 2012), the company reported a 4.8% decrease in its 2013 revenue. However, as revenue from the wireless business almost phased out in Q1 2014, TI witnessed strong growth in the first half of 2014. At $3.29 billion, Q2 2014 revenues were slightly higher than the mid point of TI’s guided range, backed by double-digit growth in both analog and embedded processing segments. Earnings per share of $0.62 was near the top of the company’s expected range on account of stronger profitability. From an end-market perspective, communication equipment witnessed the strongest growth followed by the automotive and industrial markets.

Though TI’s restructuring initiative is almost over, the company states 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. It remains focused on the analog and embedded processing markets, which it believes are the best opportunities inside the semiconductor market.

TI’s orders for Q2 2014 stood at $3.33 billion, up 7% from a year ago, and its book-to-bill ratio was 1.01. Increasing revenue contribution from the profitable analog and embedded divisions, a robust product portfolio, one of the best sales and field application engineering teams in the industry, and strong manufacturing capacity are some of the key factors that will help the company grow in the future.

Our price estimate of $40 for TI is at an approximate 20% discount to the current market price. We are in the process of updating our valuation for the company.

See our complete analysis of Texas Instruments here

Increasing Revenue Contribution from Analog and Embedded Markets to Drive Growth

After its planned exit from the smartphone and tablet market in September 2012, TI has transitioned 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. The company derived 82% of its revenue from these segments in Q2 2014 compared to approximately 72% in the quarter ended September 2012. Combined revenue for the two divisions grew by 14% year-over-year in Q2 2014. TI believes that it will continue to benefit from its investments in industrial and automotive as these important markets continue to grow as a percentage of its revenue.

TI’s analog revenue grew 14.3% annually in Q2 2014, primarily driven by power management, high-performance analog, high-volume analog, and logic and Silicon Valley analog. 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.

The embedded processing division reported its seventh quarter of consecutive year-on-year growth as TI’s investments over the past few years in strategic areas yield favorable results. In Q2 2014, embedded revenue grew 13.8% annually, driven by growth in processors and micro-controllers.

With increased investments over the past few years and new product launches, TI continues to expand its embedded portfolio every quarter. 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. However, 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. ^[1]

Gross Margin Hit New Record in Q2’14

Lower revenue, increased capacity under-utilization charges and the acquisition of its large analog competitor, National Semiconductor, impaired TI’s gross profitability over 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% on account of an improved product portfolio, higher factory utilization and increased efficiency of manufacturing operations. In Q2 2014, gross profit increased 20% annually and gross margin increased to 57.1%, hitting another new record.

The analog and embedded processing products are more profitable and less capital intensive compared to wireless products. Thus, the company benefits by deriving a larger portion of its revenue from these two divisions. In addition to a favorable revenue mix and improved manufacturing efficiency, gross margin will also benefit from lower depreciation in the future. At present, depreciation is ahead of TI’s 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.

Q3 2014 Outlook

– Revenue in the range of $3.31 billion to $3.59 billion.

– Earnings per share in the range of $0.66 to $0.76.

– Annualized savings of about $130 million by the end of 2014.

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1. The 8051 MCU: ARM’s nemesis on the Internet of Things, January 6, 2014 [↩]