TI's Growth To Accelerate As Wireless Revenue Completely Phases Out

| About: Texas Instruments (TXN)

Texas Instruments (NASDAQ:TXN), which designs and manufactures semiconductors, will announce its Q1 2014 earnings on April 23. On account of the diminishing revenue base from its legacy wireless business, the company reported a 4.8% decrease in its 2013 revenue. However, the declining revenue contribution from the wireless division improved TI’s net income by 23% as the segment offers lower margins compared to TI’s other business segments, namely analog and embedded products.

Having exited the wireless business in September 2012, TI’s restructuring initiative is almost over. However, the company claims that it will continue to monitor its investments and the market opportunities they address, to focus on opportunities that have the best potential for sustainable growth and returns. In line with this strategy, it plans to reduce costs in certain embedded processing product lines that either have matured or do not offer the desired return. TI also plans to reduce its resources in Japan, and estimates the above actions to result in annualized savings of about $130 million by the end of 2014. The company will eliminate about 1,100 jobs this year.

For Q1 2014, TI estimate a marginal decline in its revenue mainly on account of the final step-down in legacy wireless revenue. 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.

We will update our valuation for TI after the Q1 2014 earnings release.

Improving Revenue Mix To Increase Gross Margin

Lower revenue, increased capacity under-utilization charges and the acquisition of its large analog competitor, National Semiconductor, impaired TI’s gross profitability in the last few years. TI’s gross margins declined from 53.6% in 2010 to 49.7% in 2012. However, higher revenues, combined with an improving product mix and better factory utilization, increased TI’s gross margin from 47.6% in Q1 2013 to 54.2% in Q4 2013. For full year 2013, gross margin stood at 52.1%.

The quality of TI’s portfolio has improved as the company derives a larger 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. Increased loading in its most advanced factories and shutting down of older, less efficient factories (such as its Houston and Hiji 6-inch factories) is an important factor that improved TI’s factory utilization, in turn improving margins.

We believe that TI can manage to retain its margins at the current level until 2020.

Aligning Resources In The Embedded Portfolio To Aid Growth

TI plans 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. The company has clarified that is 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 year, TI expanded its embedded product portfolio by almost 20%.

Large Manufacturing Capacity Gives TI A Competitive Edge In Analogs

TI has the strongest manufacturing capability in the analog market. Though the excess manufacturing capacity might be detrimental to TI’s short-term growth, we believe that it can provide a competitive advantage to the company as demand rises. The increasing scale of operations gives TI greater control over its operational costs. TI’s capital management strategy has been to build its manufacturing base at an opportunistic cost and position well ahead of demand. Moreover, TI indicates that only half of its under-utilization expense is cash-based, which reduces the negative impact on its cash flow.

TI accounts for over 18% of the analog market and caters to over 80,000 customers from various industries such as computing, wireless communication, infrastructure, automotive, telecom, etc. With the acquisition of National Semiconductor, a strengthening product portfolio and growth in high volume analog and logic segments, we believe that the company is well equipped to leverage increasing demand for analog products. TI is the market leader in voltage regulators, which is expected to be a strong growth driver for the analog market.

Disclosure: No positions.