Texas Instruments Earnings Preview: Pessimism Has Increased Since The Last Earnings Report

About: Texas Instruments Inc. (TXN)
by: Rick Pendergraft

Texas Instruments will report earnings after the closing bell on Tuesday, October 23.

Concerns about the trade war with China have hampered the stock in recent months and that has caused an increase in pessimism.

The put/call ratio has nearly doubled since the July earnings report.

The semiconductor sector has been lagging the overall market and the tech sector as a whole for the last six months. The trade war has taken a toll on the sector as China’s biggest import is electronic chips. Dallas-based Texas Instruments (TXN) relies heavily on exports to China and the stock has been grinding sideways for most of 2018 thanks to the trade war. How heavily does Texas Instruments rely on exports to China? This is a statement from the company’s 2017 Annual Report:

We have facilities in more than 30 countries. About 85 percent of our revenue comes from shipments to locations outside the United States -in particular, shipments of products into China typically represent a large portion of our revenue.

Given that statement, investors will be anxiously awaiting Texas Instruments' latest earnings results when the company reports for third quarter after the close on Tuesday.

So far the trade dispute between the U.S. and China hasn’t had much of an impact on Texas Instruments’ earnings results. The company reported earnings growth of 36% in the second quarter and sales grew by 9%.

Over the last three years earnings have grown by an average of 25% per year while sales have grown at an average rate of 7% per year. Analysts expect earnings to grow by 30% for 2018 as a whole while sales are expected to grow by 7.6% for the fiscal year.

TI’s profitability measurements are really strong. The return on equity stands at 42.3%, the profit margin is at 40.6%, and the operating margin is at 41.8%.

The combination of earnings and sales growth along with the profitability measurements have gained Texas Instruments great ratings from Investor’s Business Daily. The EPS rating is currently a 94 with 99 being the highest rating a company can get. The SMR rating (sales growth, profit margin, return on equity) is an A and that's the highest rating a company can get.

Stuck in a $20-Range for 2018

Despite the strong fundamental performance of Texas Instruments, the concerns over the trade dispute have caused investors to exercise caution. This cautious approach has led to the stock being caught in a range between $95 and $115 for the year - yes, the stock has been above $115, but it has only closed two weeks above that level.

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Since the last earnings report on July 24, TI’s stock is down more than 12% while the S&P is only down 1.8%. This decline has caused the stock to drop below the 52-week moving average for the first time since early 2016.

The decline also has caused the weekly oscillators to fall sharply. The 10-week RSI is at its lowest level since the summer of 2015. The weekly stochastic readings are moving into oversold territory at this time and they have only been there twice in the last three and a half of years. They were briefly there in April before the stock rallies and they were in oversold territory in August 2015.

Pessimism Increased Since the Last Earnings Report

With concerns over the trade war continuing and the decline in the stock price, the sentiment toward Texas Instruments has become more bearish.

The number of shares sold short has increased from 13.4 million shares to 15.1 million shares from the end of June through the end of September. While this increase does reflect a slight increase in bearish sentiment, the short interest ratio has actually fallen during this period. The ratio was at 3.29 at the end of June and it's now at 2.51 due to a 48% increase in daily trading volume.

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The analysts’ ratings already were reflecting pessimism back in July with 16 “buy” ratings, 17 “hold” ratings, and two “sell” ratings. There has been a little change there with 14 “buy” ratings, 17 “hold” ratings, and one “sell” rating.

For a stock that has increased by more than 100% in the last three years and has the fundamental performance that Texas Instruments has had, I'm surprised at how there are more hold and sell ratings than buy ratings.

The one area where there has been the greatest amount of change in the sentiment is in the options market. The put/call ratio was at 0.87 when the company reported earnings in July. The current put/call ratio is at 1.73. There are 101,785 puts open at this time and only 58,826 calls open.

Analysts expect Texas Instruments to earn $1.53 per share on revenue of $4.3 billion. The consensus estimate has been consistent over the last 60 days.

TI beat earnings estimates in the last two quarters, but the stock reacted positively in April and negatively in July. The company only matched the estimate in January and the stock fell sharply then. Of course that was during the overall market selloff as well.

The company beat its earnings forecast last October. The initial reaction was somewhat muted with the stock trading between $95 and $100 from the end of October through the beginning of December. The stock did then jump sharply from the beginning of December through the high in January, gaining over 25% during that stretch.

My Overall Take

Given the fundamental strengths of Texas Instruments and the increase in pessimism, I'm bullish on Texas Instruments for the long term. The ongoing trade dispute with China is definitely a concern and something you will have to keep in mind if you own the stock.

If the U.S. and China can reach a trade agreement, we could see Texas Instruments and a number of other chip companies rally.

As for the reaction to the earnings report, the increase in pessimism from the options market leads me to believe that there's a better chance of a gap higher than a gap lower after the earnings report.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.