A Weak Macro Environment Impacts TI’s Q2’15 Earnings, But Long Term Fundamentals Remain Strong

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TXN: Texas Instruments logo
TXN
Texas Instruments

Texas Instruments (NASDAQ:TXN) reported its Q2 2015 earnings on July 22nd and, as anticipated by the company, the weak economic environment impacted its growth rate in the quarter. TI closed 2014 on a strong note, with revenue and net income growing 7% and 30%, respectively, as the company’s growing strength in analog ICs and embedded processing was bolstered by an efficient manufacturing operation and a broad sales channel. However, TI’s growth slowed down in Q1 2015 on account of the delay of investments by carriers and capacity upgrades for wireless infrastructure equipment, a weaker than expected refresh cycle for Windows XP commercial desktops, and adverse currency headwinds. The weakness persisted in Q2 2015, and TI expects the trend to continue in the current quarter as well.

In Q2 2015, TI saw strong growth in the automotive segment, with almost all sectors inside this market growing at double-digit rates. Industrial revenue was about flat, in contrast to last quarter’s year-over-year growth, and was incrementally weaker than expected. Communications equipment declined primarily due to the wireless infrastructure sector, which was down about 50% from a year ago and even weaker than TI had initially expected. While the trend in demand will continue to vary by end-market, TI expects the the total addressable market to be weaker (year on year) in Q3 2015 compared to Q2 2015.

The short-term headwind is more of a macro issue as TI’s fundamentals remain strong. The company estimates its sales force team to be three to four times larger than its nearest competitors. Possessing scale and product breadth 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 increase operating expenses as fast as revenues.

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Our price estimate of $50 for TI is almost in line with the current market price.

See our complete analysis of Texas Instruments here

A Quick Snapshot of Q2 2015 Earnings

TI’s Q2 2015 revenue stood at $3.2 billion, declining 2% year on year. In addition to notably weak demand in communications equipment, the company had a $45 million negative impact (year over year) from currency exchange rates, as expected. Gross margin stood at 58.2%, flat compared to Q2 2014, as the company benefited from lower manufacturing costs. TI has managed to improve its gross margins on account of efficiencies of its manufacturing strategy, which includes the growing 300-millimeter Analog output, and the opportunistic purchase of assets ahead of demand. Free cash flow stood at 27% of revenue, consistent with the company’s targeted range of 20% to 30%. Earnings per share for the quarter came in at $0.65, a $0.03 improvement compared to Q2 2014. TI’s orders in the quarter were $3.26 billion, down 2% from a year ago.

Analog Business Continues To Grow, But The Embedded Division Impacted By Weakness In Wireless Infrastructure

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, which now form the company’s core business. The company continues to invest its R&D dollars into several high-margin, high-growth areas of the analog and embedded processing markets. Even in the weak macro environment, the combined Analog and Embedded Processing business grew slightly and comprised 85% of TI’s total revenue in Q2 2015, compared to 79% in 2013.

TI’s analog division reported its eighth consecutive quarter of year on year growth as revenue increased by 3% year on year in Q2 2015. Growth in the quarter was driven by a slight uptick in High Volume Analog & Logic as well as Power Management. Silicon Valley Analog was even, while High Performance Analog declined in the quarter. Operating profit margin for the analog division stood at 35.5%. TI has increased its R&D investments in the sector by more than 75% since 2006, which has resulted in steady increases in market share over the years. The company increased its share in the analog market to 18.3% in 2014, compared to 16.8% in 2013.

After 10 consecutive quarters of year on year growth, TI’s embedded revenue declined 2% in Q2 2015 due to the weakness in wireless infrastructure equipment for the processor product line, which offset the increase in connectivity and microcontroller product lines. Despite the decline in revenue, the embedded processing operating profit margin was up 5 percentage points year on year, as TI benefited from its investments for growth and strong execution of its restructuring plan to better align resources with the opportunities that it is pursuing.

In late 2010-early 2011, TI significantly stepped up its investments in the embedded market in order to accelerate its product introductions. TI continues to invest energetically, though at a lower level compared to the past. The high level of investment and an expanding product portfolio from heavier levels of investment in the prior few years, will continue to drive growth in the future as well, in our view.

Q3 2015 Outlook

– Revenue in the range of $3.15 billion to $3.41 billion, including a negative impact of about $40 million due to changes in currency exchange rates.

– EPS to be in the range of $0.62 to $0.72.

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