Texas Instruments (NYSE:TXN) stock price has increased by over 50% since the company made a conscious decision to exit its wireless business in September 2012. Though the diminishing revenue from the division impacted TI’s top line, it improved its net income by 23%, in 2013, as the proportion of revenue earned from the low margin wireless business declined throughout the year.
We believe that the higher revenue contribution from the profitable analog and embedded divisions, a robust product portfolio, one of the best sales and field application teams in the industry, and strong manufacturing capacity will help spur TI’s growth in the future. However, our price estimate of $38 for Texas Instruments is at a 20% discount to the current market price. We believe the we have adequately accounted for TI’s growth prospects in our valuation.
In addition to improving financials, TI’s stock price was also pulled up by the positive sentiment around semiconductor stocks, as the industry continues to recover from a slump in late 2012. We hold on to our estimates until the company reports its Q1 2014 earnings later this month.
In this article, we list down recent developments that contributed to TI’s stock price increase and point out certain scenarios which will increase our valuation for the company by approximately 20%.
Factors That Increased TI’s Stock Price
- TI’s exit from the wireless market: TI exited the wireless business on account of the intense competition in the market and declining profits. With Nokia (NYSE:NOK) as a major customer, it had once led the industry. Yet the emergence of the smartphone fostered the radical ascent of Qualcomm (NASDAQ:QCOM) and Samsung (OTC:SSNLF), as the Android and iPhone platforms achieved dominance. As a result, the company generated just 10% of its revenue and earned the lowest margins (16%) from the wireless segment in 2012. TI’s wireless revenue phased out at the end of 2013. The higher proportion of revenue from the more profitable analog and embedded divisions will help spur top line, as well as bottom line growth for the company.
- Increased dividend payout: TI raised its quarterly cash dividend twice last year (total increase was >40%), from $0.21 per share to $0.30 per share. Returning more cash to shareholders is one of TI’s key strategy. The company remains confident that its business model is well positioned to generate $0.20 to $0.25 per share of free cash flow for every dollar of revenue that it earns in the future. TI reported free cash flow of $3 billion for full year 2013.
- Restructuring the embedded business: In January this year, TI announced its decision to reduce costs in certain embedded processing product lines that either have matured or do not offer the return opportunities the company is looking for. TI has clarified that it 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. It expects the ongoing changes to improve the profit margin in embedded business while still maintaining its pace of growth.
With new product launches, TI continues to expand its embedded portfolio every quarter. It believes that the embedded markets (currently sized at $19 billion) offer greater potential for sustainable growth compared to mobile devices. In the last one year, TI expanded its product portfolio by almost 20%.
Factors That Can Increase Our Price Estimate By 20%
1. TI’s analog market share rises to 25% (15% Upside): TI’s analog product portfolio consists of high volume analog & logic, high-performance analog and power management circuits. It caters to over 80,000 customers from various industries such as computing, wireless communication, infrastructure, automotive, telecom, etc. TI is the market leader in voltage regulators, which is expected to be a strong growth driver for the analog market. The segment contributes around 30% to TI’s total analog division revenue.
With the acquisition of National Semiconductor, a strengthening product portfolio and growth in high volume analog and logic segments, the company is well equipped to leverage increasing demand for analog products. TI currently accounts for 18% of the analog market and we estimate its market share will reach 20% by the end of our review period. However, if our forecast turns out to be too conservative and TI’s market share reaches 25% over our review period, there will be a 15% upside to our valuation for the company.
2. TI’s company wide gross margin reaches 55% (5% Upside): TI’s gross margins declined from 53.6% in 2010 to 49.7% in 2012 as lower revenue, increased capacity under-utilization charges, and the acquisition of National Semiconductor impaired its profitability in the last few years. However, higher revenues, combined with an improving product mix and better factory utilization, increased TI’s gross margin to 52% in 2013.
We currently forecast TI’s gross margins to increase marginally (to 52.6%) over our review period. However, if the margins increase to 55% there will be a 5% upside to our price estimate.
The quality of TI’s portfolio has improved as the company derives a higher proportion of its revenue from higher value analog and embedded processing products, which are more profitable and less capital intensive compared to wireless products. The Analog and Embedded segments accounted for 79% of TI’s revenue in 2013, as compared to 72% in 2012. A rising proportion of revenue from these two divisions, along with an increased loading in TI’s most advanced factories and shutting down of older, less efficient factories (such as the Houston and Hiji 6-inch factories), can further improve margins in the future.