For Texas Instruments, The Song Remains The Same

By Stephen D. Simpson, CFA | July 24, 2012 AAA

For all the talk of how supply chain and customer inventories are scraping the bottom, there's just no momentum in the broad semiconductor sector. Once again Texas Instruments (Nasdaq:TXN) found itself with a tougher-than-expected quarter and once again guidance is heading lower. While it remains a fine company with significant untapped potential, investors have to realize that the potential may stay on ice for a while longer.

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Not Much Joy in the Second Quarter
With Texas Instruments having guided down analysts' expectations during the quarter, most of the surprises from the final second quarter report were positive. That said, it's almost becoming a comedy routine to talk about how a broad sector recovery is "imminent."

Texas Instruments reported that revenue fell nearly 4% from the year-ago level, but rose 7% sequentially. Analog was strong on the back of good sales in areas like power management, and sales rose more than 13% from last year and about 6% sequentially. Wireless continues to erode as part of a scheduled wind-down of the business.

SEE: The Most Important Metrics For Earnings Season

All things considered, Texas Instruments did alright on margins. Gross margin did pull back from last year's level (by more than a point), but improved about half a point from the first quarter. Operating income was mixed - down significantly from last year (either on an as-reported or adjusted basis), but also up significantly on a sequential basis.

Texas Instruments' Margin Irony
One of the bull stories on Texas Instruments for the last year or so was that the company's decision to build up capacity was going to improve the margin structure and allow it to chase ostensibly lower-margin business without hurting its own margins. Because of the soft demand from customers, though, that excess and under-utilized capacity is actually weighing down margins here and now.

SEE: A Look At Corporate Profit Margins

Strong Competitors, Weak Customers
Texas Instruments is finding itself playing the role of the rope in a game of industry tug-o-war. On one side, major customers like Research In Motion (Nasdaq:RIMM), Nokia (NYSE:NOK) and Google's (Nasdaq:GOOG) Motorola are all losing share in the smartphone market to the likes of Apple (Nasdaq:AAPL) and Samsung. Among Texas Instruments' major customers, only Amazon (Nasdaq:AMZN) is looking relatively strong (in the tablet business).

On the flip side, Broadcom (Nasdaq:BRCM) and Qualcomm (Nasdaq:QCOM) are doing more than just holding their own. Moreover, if Nvidia (Nasdaq:NVDA) and Intel (Nasdaq:INTC) are really serious about building mobile processing share (and are willing to pay the cost), it's only going to get harder for Texas Instruments.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
The good news at Texas Instruments is that it's not alone. Although the company definitely lowered guidance for the next quarter (issuing a sequential growth range of negative 4% to 4% against a prior Street estimate of nearly 6%), it wasn't really out of line with what we've heard from companies like Freescale (NYSE:FSL), STMicroelectronics (NYSE:STM) and so on. What's more, with enough capacity to serve nearly a quarter of the market, there's definitely dry powder on hand.

The question is how patient investors can be with these shares. I think Texas Instruments can outperform in an industry recovery, but that surplus capacity will weigh heavily on results if demand weakens even further. This is not my favorite semiconductor company by a long stretch, but it is at least modestly undervalued today on the basis of an 18-24 month outlook.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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