Texas Instruments’ (NYSE:TXN) results are symbolic of the current macroeconomic conditions affecting the semiconductor business. The firm’s most recent quarter three results have shown weakness in the end market, further raising fears that the continued trade war between China and the United States may have negative ramifications on the semiconductor business.
Despite the 25.4% year-over-year (YoY) and 13% subsequent quarter-over-quarter (QoQ) EPS growth to $1.58 which beat analysts’ expectations in 3Q18, the revenue growth rate in 3Q18 declined drastically to 3.5% (YoY) and 3.9% (QoQ) to close the quarter at $4.3 billion, a significant decline in growth rate from the near 8% (QoQ) growth witnessed in the 2Q18. The firm further expects a decline in their expected 4Q18 revenue associated with the end market.
Semiconductor Division: Investors Remain Unimpressed
The semiconductor business has continued to raise fears among investors. This is especially so because of the heightened tension associated with the continued trade wars between the United States and China. Courtesy of the establishment of manufacturing industries of most multinationals within China – including major players such as Apple (NASDAQ:AAPL) – the increase in tariffs is expected to have an adverse impact on businesses.
(Source: Market Realist)
Despite management having not stated categorically that the China-US trade war has had an impact on their operations, they did not expressly rule this out. The trade war China is expected to have had significant ramifications on the financial performance of major semiconductor industry players. Furthermore, these firms expect that 4Q18 will be the worst hit by this trade war and are currently working towards mitigating the expected decline in business expected then.
(Source: Market Realist)
The result of this has been firms failing to stock up on inventory as a means to hedge against the expected decline in demand. In light of the expected decline in demand, firms have been discouraged from stocking up, especially so given that they are uncertain about using these products in production over the near future. Currently, a wait and see approach has been adopted as they review the market and make the necessary adjustments to their procurement process. The result has therefore been that the chipmakers – TXN, Micron (NASDAQ:MU) and Taiwan Semiconductor Manufacturing Co. (NYSE:TSM) – have continued to build up on their inventory as shown in the chart above.
Texas Instruments has, however, continued boosting their bottom lines. Despite the decline in the revenue, the firm’s operating profits continued to rise. Profit margins hit two-year highs this quarter as their gross profit margin and operating profit margin rose to 65.8% and 45.5%, respectively. Moreover, the commensurate increase in the firm’s earnings per share to $1.58, beating analysts’ expectations of $1.53, speaks to the firm’s resolve to ensure that their bottom lines are solidified, ensuring that their investors don’t miss out on their expected return and that their valuation remains consistent.
The revenue generation is bifurcated into analog, embedded processing and other segments. The three segments brought in $2.91 billion, $894 million and $460 million in revenues: 68.2%, 21% and 10.8% of the total revenue, respectively. Of the three, the analog segment provided the highest growth, with an 8% year-over-year growth, while the other two segments declined by 4% and 5.5%, respectively. The positive performance of the analog segment has been associated with the good performance of power and signal chain products, a factor which the firm states their research and development department has been working at improving.
Finally, the firm’s debt to equity ratio currently stands at 0.48, quite low for a player in the industry. This leverage therefore provides them the opportunity to generate higher returns per unit equity (return on equity) which currently stands at 45%. The debt portion, despite exposing the firm to the risk of interest rate movements, not only showcases the quality of business the firm is running but also allows the firm to increase shareholder return associated with a fueled ROE. The downturn in the industry seemed to have a lower impact on Texas Instruments which provided investors with a much higher ROE than the 13% ROE which firms operating within the semiconductor industry averaged at.
Beating the Expected Industry Decline
It is clear that the demand from the end market is expected to decline over the coming quarter. As a result, producers such as Texas Instruments are working out different options to ensure they mitigate the risk of higher fixed costs associated with increased inventory as well as factory overheads due to consistent production.
Currently, the firm’s management pointed out that they would be producing more of durable (long life cycle) components so as to mitigate against the risk of the products becoming obsolete. This period also offers them the ability to venture into the development of more advanced nodes. Furthermore, it also becomes clear that despite the downturn affecting the firm, their investment in general chips rather than specialized chips also ensures that the firm is affected less adversely by either demand swings or products becoming obsolete.
Company Specific Details
As at the last quarter, the firm’s research and development increased. The firm believes that the continued investment will act as a catalyst to the expansion of their portfolio and eventually in revenue generation. Investment in both the automotive and industrial market segments has continued to prove prudent as witnessed by the double-digit growth in the two segments. However, the decline in the communications equipment and the personal electronics markets which exhibited low single-digit growth and declining growth, respectively, were key factors affecting the bottom lines.
View on the Stock
There is a lot that’s expected of TXN; however, for the next quarter, a decline in the performance seems inevitable. With this in mind, we believe that the stock is a hold in the near term. This will offer investors the chance to assess the risks associated with the expected downturn. Eventually, however, it is our opinion that the stock is a buy for the long term, but this is pegged on their research and development department providing positive results as well as a resurgence from the expected downturn in their short-term financial performance.
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.