Texas Instruments (NASDAQ:TXN), which designs and manufactures semiconductors, will report its Q2 2014 earnings on July 21. On account of the diminishing revenue base from its legacy wireless business (TI exited this business in September 2012), the company reported a 4.8% decrease in its 2013 revenue. However, it started its fiscal 2014 on a strong note as revenue from its legacy wireless business almost phased out in Q1 2014. TI expects to retain its growth momentum in Q2 2014 and forecast revenue in the range of $3.14-$3.40 billion, which translates into annual growth between 3% to 12%.
Though TI's restructuring initiative is almost over, the company states that it will continue to monitor its investments and the market opportunities they address to focus on those that have the best potential for sustainable growth and returns. It plans to eliminate and reduce its resources in Japan. The above actions will result in annualized savings of about $130 million by the end of 2014.
Increasing 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.
Our price estimate of $40 for TI is at an approximate 20% discount to the current market price. We will update our valuation after the Q2 2014 earnings release.
New Products To Expand TI's Presence In The Growing Embedded Market
Since its exit from the smartphone and tablet market in September 2012, TI has been focusing on transitioning its operations to become a pure analog and embedded processing company, segments that it believes will offer long term growth and less volatility, compared to the past. With a market share of 17%, TI is one of the leading player in the analog semiconductor market, and derives over 60% of its revenue from this division. On the other hand, TI derives only 22% of its revenue from the embedded division. However, the fast expanding embedded market (currently sized at $19 billion) offers significant growth opportunities for the company. In the last one year TI expanded its embedded product portfolio by almost 20%.
TI's embedded processing revenue grew 8.6% and 17.0% year over year in 2013 and Q1 2014, respectively, on account of strong demand for microcontrollers. The company introduced its latest 32-bit dual-core Hercules microcontrollers (MCUs), for industrial, medical, automotive and transportation design applications in May this year. The two new variants (RM57Lx and TMS570LCx) offer a 50% increase in computational performance over any of TI's current MCUs, allowing system designers to utilize a single Hercules MCU to replace several discrete MCUs. In the Internet-of-things (IoT) space, minimal power consumption and the lowest possible cost are two key requirements. Microcontrollers, which are purpose-dedicated, low-cost logic devices, currently dominate the market for IoT. Gartner estimates the IoT market to grow almost 30 times, from an installed base of 0.9 billion in 2009 to 26 billion by 2020.
Last month, TI also introduced its new SimpleLink Wi-Fi platforms (CC3100 and CC3200) for IoT applications, which enables customers to simply and securely add embedded Wi-Fi to a wide-range of home, industrial and consumer electronics, using a phone or tablet applications.
With increased investments in this growth area over the past few years and new product launches, TI continues to expand its embedded portfolio every quarter. TI plans to reduce investment in certain embedded processing product lines that either have matured or do not offer the return opportunities it is looking for. However, 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.
Improving Revenue Mix Will Improve Gross Margin
Lower revenue, increased capacity under-utilization charges and the acquisition of its large analog competitor, National Semiconductor, impaired TI's gross profitability over 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 to 52.1% in 2013. In Q1 2014, gross margin further improved to 53.9% on account of an improved product portfolio, higher factory utilization and increased efficiency of manufacturing operations.
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. Increased loading in its most advanced facilities and the closure of older, less efficient fabs (such as the Houston and Hiji 6-inch facilities) have together driven an increase in TI's factory utilization, in turn improving margins.
At present, TI's depreciation is $459 million ahead of its 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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