Previewing Texas Instruments’ First Quarter – The Bottom Should Be In Sight, But Capex May Pressure Margins
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Summary:
- Texas Instruments’ first quarter is likely to resemble recent quarters, with modest revenue outperformance and healthy operating margins relative to expectations, but possibly soft guidance.
- The auto end-market remains healthy and enterprise and personal electronics should improve, but industrial offers some downside risk, particularly with MCU share losses.
- Mid-single-digit revenue growth and high single-digit FCF growth don’t really support an attractive fair value today, and TI could be a somewhat later name to rally.
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Investors are increasingly confident that the worst is in sight (and in the numbers) for the semiconductor sector, and that has helped push the sector up about 20% year-to-date. As I highlighted in my last piece, though, there are still some ongoing challenges and valuation concerns with Texas Instruments (NASDAQ:TXN), and while this remains an incredibly well-run leader in the field, the shares have lagged as I thought they might, underperforming by more than 10% and underperforming names like Renesas (OTCPK:RNECY) and STMicroelectronics (STM) even more.
At this point I still have mixed feelings about TI. I think first quarter results are likely to shape up as I previewed before with the fourth quarter results – a small beat on revenue and solid operating margins, but a weaker guide. The worst should be over in the personal electronics space and auto should remain healthy, but industrial could soften more, and I do have some concerns about share loss in the microcontroller (or MCU) business. Given all of that, while I wouldn’t be highly motivated to sell TI shares and chase some of the best-performing names, I also don’t find today’s share price all that exciting.
First Quarter Results – History Doesn’t Repeat, But It Often Rhymes
From a broad perspective, I expect the first quarter report and forward guidance from TI to be similar to what we saw in the fourth quarter – a modest beat in the quarter that was and cautious guidance for the next quarter.
Revenue should be down a little more than 6% sequentially in the quarter, with ongoing growth in the auto business and ongoing weakness in personal electronics and likely weakness in the industrial end-markets as well. It is here, in the industrial space, where I see the most downside risk as semiconductor lead-times have continued to shrink and customers continue to work down inventories in response to supply chain improvements and uncertain demand in their own outlooks.
I do expect gross margin to decline around 150bp (to 64.6%), and I could see downside closer to 64% here. TI has shown a remarkable ability to offset gross margin pressure with operating leverage, and I expect that will be true again relative to sell-side estimates, but I do think operating margin will fall by more than three points to around 43%.
As one of the first chip companies to report and a bellwether for the sector, guidance for the next quarter will carry more weight for the stock price performance than Q1’23 results. To that end, it’s worth remembering that TI has a track record of conservative guides, and given greater forecasting uncertainties (weak PMI but other metrics still healthy, softer lending outlooks from many banks, et al), I could see a below-Street guide (the Street is currently looking for 1.6% qoq growth for Q2’23), with some risk of another sequential decline.
Industrial Is Likely To Be The Point Of Pain
Looking at the end-markets that drive TI’s guidance and revenue, I’m least concerned about the auto market. OEMs are still trying to build inventories and the outlooks from auto MCU companies have remained strong, with many companies already noting sold-out order books for auto MCUs in 2023.
On the good, TI is targeting attractive opportunities across the auto sector, including ADAS, infotainment, interior (body/cabin/lighting), and powertrain (including battery management) with both its MCU and high-performance analog offerings. On the bad side, I expect auto volumes to slow and I have some concerns that reduced consumer confidence and auto lending could depress demand (and build volumes) later this year.
Industrial is the market that concerns me most, but that’s more from a modeling uncertainty point of view than in terms of absolute revenue declines. Many well-regarded industrial sector CEOS are looking for a mild recession in 2023 and March’s PMI number was the seventh straight reading below 50, which doesn’t exactly bode well.
On the positive side, markets like aero/defense, automation, medical, and renewables should offer growth in ’23. On the negative side, recent Gartner data suggests that TI lost 260bp of market share in industrial MCUs in 2022, marking the fourth straight year of share loss. With companies like Microchip (MCHP), STMicro, and Renesas stepping up their 16-bit and 32-bit offerings, TI has fallen behind and I have some modest concerns about the extent to which the company may be getting elbowed out of some attractive opportunities in areas like automation.
The Outlook
I do think that most multi-market semiconductor companies will see a return to sequential growth in Q2’23 and a return to year-over-year growth in the second half of 2023. There are clearly still risks in areas like industrial and consumer electronics, not to mention risks tied to turbulence in the banking sector, but I think the worst is in sight even if the exact timing is off by a quarter.
TI’s longer term outlook is more interesting now that management has meaningfully increased its capex guidance (from $3.5B a year through 2025 and 10% of revenue thereafter to $5B/year through 2026 and 10%-15% thereafter). I think adding more 300mm capacity makes a great deal of sense, but I do have some concerns that the 10% long-term annualized revenue growth target could be too bullish.
Management expects to maintain free cash flow margins in the 25%-35% range, but while the bottom end of that would still be good, it’s a rather wide spread of potential outcomes. In the near term, capacity additions pressure margins and I think 50%-plus operating margins will be hard to attain again for quite some time.
I’m expecting 6% revenue growth from FY’22 results (or closer to 8% adjusting for the exceptional growth of the last two years), and I expect long-term adjusted FCF margin to average out around 31.5% – a bit better than the trailing 10-year average. All of that supports a roughly 7% annualized expected total return today, which is not terrible, but not great either. A multiples-based approach tied to margins gives me a fair value in the $170’s, but I do see upside to that target over the next 12 months as investor sentiment improves towards semiconductors.
The Bottom Line
At this point I’d rather look at AI/compute and networking-sensitive chip names, and runs in some of my favorite names (like STMicro and Renesas) has shifted the landscape. I don’t think long-term investors in TI need to be all that concerned right now, but I don’t find the return prospects today to be all that exciting.
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