TI To Close 2014 On A Strong Note: Earnings Preview

Texas Instruments (NASDAQ:TXN), which designs and manufactures semiconductors, will report its Q4 2014 and year-end 2014 earnings on January 26th. 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 top line growth in 2014. For the first three quarters of fiscal 2014, TI’s revenue grew 6.5% compared to the same period last year. Additionally, owing to record gross margins and prudent expense management, TI’s net income increased by 20.9% during the same period. For Q4 2014, the company expects revenue in the range of $3.13 billion to $3.39 billion and earnings per share in the range of $0.64 to $0.74.

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 strategy is centered around analog ICs and embedded processing and is bolstered by an efficient manufacturing operation and a broad sales channel. The company is growing its 300 millimeter output and continues to follow the strategy of purchasing assets ahead of demand at the stressed prices. It estimates its sales force team to be three to four times larger than its nearest competitors. Possessing scale others lack, it is beginning to get a lot more revenue per sales person which gives it the ability to grow revenue without having to grow operating expenses as fast as revenues.

Our price estimate of $42 for TI is at an approximate 15% discount to the current market price. We will update our valuation after the Q4 2014 earnings release.

See our complete analysis of Texas Instruments here

Analog & Embedded Divisions Continue To Be Key Growth Drivers

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 the first nine months of  2014, compared to approximately 78% last year. With a market share of 17%, TI is one of the leading players in the analog semiconductor market, and derives over 60% of its revenue from this division. On the other hand, TI derives only 21% of its revenue from the embedded division and accounts for 13% of the global embedded market.

TI’s revenue growth in the analog market is being driven by power management, high volume analog and logic, high performance analog and Silicon Valley analog (products and assets acquired with National Semiconductor). The company expected to gain additional market share in analog 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 eighth quarter of consecutive year-on-year growth in Q3 2014, as TI’s investments over the past few years in strategic areas have yielded favorable results. Growth is this segment is mainly being driven by processors, connectivity and micro-controllers, which account for 50%, 45% and 5% of its embedded revenue, respectively. While TI has a leading market share in processors, the company is still relatively under-represented (6% market share) in the microcontroller market. Over the last 3-4 years, TI has increased its focus on microcontrollers. Over the last few years, TI has expended its investment to broaden its microcontroller portfolio and increase its application support for the product, which has helped the company increase its market share. The company now has a wider product portfolio with microcontrollers ranging from $0.25 up to a couple of dollars using all different combinations of its connectivity products.

According to Grand View Research, the global microcontroller market is expected to reach  $27 billion by 2020, driven by growing demand from industries, such as automotive and consumer electronics, and the advent of the Internet of Things (IoT), coupled with declining microcontroller prices.

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

Gross Margin To Hit A New Record In 2014

Having seen its gross margin decline from 53.6% in 2010 to 49.7% in 2012, on account of lower revenue increased capacity, under-utilization charges and the acquisition of its large analog competitor, National Semiconductor, TI has marked a continuous improvement in gross margin since 2013. In 2014, TI’s gross margin hit new records and stood at 56.6% for the first nine months compared to 51.5% during the same period last year. 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, the 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.

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