Macro Weakness To Impact TI’s Q3’15 Earnings, But Long-Term Growth Remains Intact

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TXN: Texas Instruments logo
TXN
Texas Instruments

Texas Instruments (NASDAQ:TXN) will report its Q3 2015 earnings on October 21st. While the company closed 2014 on a strong note, its growth slowed down in the first half of 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. TI expects the weakness to persist in Q3 2015 as well, with the total addressable market to be weaker (year-on-year) in the quarter, compared to Q2 2015.

We believe that the short-term headwind is more of a macro issue as TI’s fundamentals remain strong. The company continues to strengthen its analog ICs and embedded processing portfolio, which combined with an efficient manufacturing operation and a broad sales channel will drive its long-term growth. TI 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.

Our price estimate of $50 for TI is just marginally lower than the current market price. We will update our valuation after the Q3 2015 earnings release.

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See our complete analysis of Texas Instruments here

Analog Business Continues To Grow . . . 

Despite the macro weakness, TI’s analog division reported its eighth consecutive quarter of year-on-year growth in Q2 2015, driven by a slight uptick in High Volume Analog & Logic as well as Power Management. 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.

In the last few months, TI has accelerated its chip development cycles and is penetrating speedily in fast growing markets such as automotive and industrial machines. We believe that a strengthening analog portfolio will enable TI to retain, or even marginally increase, its marker share over the next few years.

 . . . But The Embedded Division Will Be Impacted By Short-Term Weakness In Wireless Infrastructure

After reporting 10 consecutive quarters of year-on-year growth, TI reported marginal decline in its embedded processors revenue, as the weakness in wireless infrastructure equipment for the processor product line offset the increase in connectivity and microcontroller product lines. The continued weakness in wireless infrastructure is likely to impact the company’s embedded revenue in the short term. However, the long-term growth prospects remain intact.

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.

On The Positive Side, Gross Margins Remain Strong

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. The company’s gross margin increased from 52.1% in 2013 to 56.9% in 2014, and hit a new high of 58.2% in Q2 2015 (despite the slow top line growth).

Increased factory load-ins, and an improved product portfolio focused on analog and embedded processing that benefits from an efficient manufacturing strategy, are some of the key factors that have helped TI seen a continuous improvement in its gross margin. 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. The combined analog and embedded processing revenue accounted for 85% of TI’s total revenue in Q2 2015, as compared to 79% in 2013.

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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