Sometimes "less bad" passes for better on Wall Street, and such may be the case for Texas Instruments (NYSE:TXN). Although the company's second quarter results and third quarter guidance don't suggest a rampant recovery in the chip sector, it does seem that business has stabilized. Even still, investors would likely do well to remain suspicious and cautious.
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A Second Quarter More or Less As Expected
The results that Texas Instruments reported late Monday seemed more or less consistent with the company's earlier guidance. Revenue fell 1% from the year-ago period, but rose 2% on a sequential basis. Growth was boosted by strong results in embedded chips, held back by wireless, and analog was more or less in line with the company averages.
As is so often the case for large chip companies like Texas Instruments, operating leverage cuts both ways. With lower revenue, Texas Instruments lost 20 basis points in sequential gross margin and three and a half points from the year-ago level. Likewise, operating income slid slightly from the first quarter and dropped significantly (18%) from the year-ago level.
Always Plenty of Moving Parts at TI
For the second quarter declines in the wireless baseband business played a significant role in the company's overall wireless weakness. This is a one-customer business (Nokia (NYSE:NOK)) and TI is basically backing away (with Nokia turning to rivals like Broadcom (Nasdaq:BRCM) and STMicroelectronics (NYSE:STM) for some of its needs).
On the other hand, TI's OMAP business still has the Motorola Mobility (NYSE:MMI) Droid business and perhaps the Research In Motion (Nasdaq:RIMM) PlayBook will somehow turn into a winner.
How Will TI Respond to the Competition?
Texas Instruments sported a positive (above 1) book-to-bill this quarter and 5% sequential inventory growth is not too troubling. In fact, it may help its status with customers as worries of supply shortfalls often motivate customers to line up multiple suppliers.
Also helping matters should be the company's new fab. With state-of-the-art lower-cost manufacturing in place, this should allow TI to compete more effectively on price without risking margins. Given that the price competition / margin trade-off is a seemingly ever-present concern for investors in analog names like TI, Analog Devices (NYSE:ADI), Maxim (Nasdaq:MXIM) and Linear Technologies (Nasdaq:LLTC), this should be a helper over the next 18-24 months.
That doesn't resolve all of TI's competitive concerns, however. Broadcom and Qualcomm (Nasdaq:QCOM) are fierce rivals in growth markets like smartphones and tablets, and both Nvidia (Nadsaq:NVDA) and Intel (Nasdaq:INTC) want a bigger presence in this market as well (in fact, Motorola chose to go with Nvidia for its Xoom tablet). This is a great set-up for companies like Motorola, RIM and Apple (Nasdaq:AAPL) - several high-quality suppliers who all need growth and may be willing to give up a little pricing to get it.
The Bottom Line
Arguably the biggest issue for Texas Instruments is the extent to which it can boost free cash flow margins over its historical levels. The new fab and the National Semiconductor acquisition will help, but odds are that there is not as much upside as bulls believe.
For now, investors should also consider names like Atmel (Nasdaq:ATML), Cavium (Nasdaq:CAVM) and Mellanox (Nasdaq:MLNX). Mellanox in particular is another way to play solid enterprise data demand, given the company's position with companies like IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ), and EMC (NYSE:EMC) - all of which reported good demand in enterprise data.
For Texas Instruments, the stock is below fair value today, but the Street doesn't seem quite ready to embrace chips again. TI is not play on the sector, but investors need to consider that cash flow conversion question - the extent to which TI is undervalued today really does seem to hinge on just how good the long term margin potential is. (For related reading, also see A Primer On Investing In The Tech Industry.)
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