How Texas Instruments Can Expand Its Gross Margins
Over the past few years, Texas Instruments (NYSE:TXN) has been focusing on the industrial and automotive markets, which are seeing increasing semiconductor demand. The company is also extensively focusing on the 300-millimeter analog fabrication vertical as 300 mm wafers cost about 40% less than an unpackaged chip built on 200-millimeter wafers, the size used by many of TI’s competitors.
This strategy has helped Texas Instruments to improve its gross margins from under 50% in 2012 to 61.6% in 2017. The trend has continued in 2017, with margins expanding further to 64.3% in Q2 and 64.5% in Q3.
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Margins Set To Grow Further
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We believe that Texas Instruments’ margins will continue to improve in the next couple of years due to the following reasons:
- Increasing revenues from Analog vertical: The revenue contribution from the Analog vertical, which employs 300 mm fabs, has gone up from 55% in 2012 to over 64% in 2016. In the past nine months, Analog’s contribution has increased to around 66%. We expect TI to increase its Analog product revenues further due to its focus on the industrial and automotive markets. This can help the company to improve its gross margins from the low 60% range currently to 68% by the end of our forecast period, as 300mm production can help drive down the company’s production costs.
- Increasing investment in 300mm Fabs: The company is increasing its manufacturing footprint for 300mm wafers, so the company will be able to support about $8 billion of annual Analog revenue on 300-millimeter wafers. TI pointed out in its presentation about its capital management strategy that it can achieve 68% gross margins for analog chips manufactured on a 300mm wafer. As Analog sales increase, the company should post higher margins in the future.
- Utilization set to grow in the coming years: The proportion of TI’s revenues from 300mm production is likely to increase in the coming years, driving the company’s margins higher. To increase its 300mm production, the company is likely to ramp up its production from RFAB and DMOS6 facilities, which cater to 300mm production, and were largely under-utilized until 2016. TI’s RFAB and DMOS6 production facilities were operating at 45% and 25% of their full production capacity, respectively.
- In addition to a favorable revenue mix and improved manufacturing efficiency, the company’s 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 expenditures to remain at relatively low levels (4% of revenue) for the next few years. As depreciation starts to come down over the next couple of years, it will boost gross margins.
We currently have an $80 price estimate for Texas Instrument’s stock, which is nearly 20% below the current market price.
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