Texas Instrument Inc. (TXN, Financial) is a technology company closely monitored by both analysts and investors to gauge the prospects for the tech sector. The company is one of the world's largest and most profitable semiconductor manufacturers.
Despite double-digit growth in both revenue and earnings in each of the last five quarters, Texas Instruments' stock has declined close to 7% in the last 12 months. The company has lost more than 6% of its market value this year alone, though it has outperformed the S&P 500 handsomely, which is down 17% in 2022.
The company recently issued lackluster guidance for the fourth quarter, which may spook investors, but it doesn't negate the company's long-term potential. In this analysis, we will review the prospects for the company to determine whether Texas Instruments could still offer good value despite short-term pain.
Business basics
Texas Instruments designs and manufactures semiconductors and analog chips for use in a variety of industries, including consumer electronics, automotive, communications and industrial equipment. The company operates under two main segments: Analog and Embedded Processing. The segments focus on developing analog and digital signal processing integrated circuits (ICs) that are engineered for a wide range of applications, including smartphones, tablets, cameras, infotainment systems, medical equipment and more. The company also provides display and projection products that offer high-resolution images for display applications.
The slowdown in personal equipment demand is a major concern
Texas Instruments has been very profitable in recent years. The company reported record revenue of $5.24 billion in its most recent quarter, an increase of 13% from the previous year. The company also earned over $2 billion in net income in the same period. However, despite the strong financial performance over the past few years, shares of Texas Instruments have been in steady decline recently because of a few concerns regarding the demand outlook.
One big concern is that Texas Instruments is seeing slower demand for its products due to slowing economic growth in China. The company’s Analog segment has experienced a significant drop in revenue in China, which is dire because the region accounts for 25% of revenue.
According to the Semiconductor Industry Association, global semiconductor sales fell 3% year-over-year in September, the first monthly decline since January 2020, with China suffering the most, falling 14%.
As a result, revenue from the Analog segment increased by only 13% year-over-year in the third quarter. Meanwhile, sales in Embedded Processing increased by 11%.
Exhibit 1: Segment-wise year-over-year revenue growth
Source: Texas Instruments nvestor presentation
According to the company, the slowdown in growth is due to weakness in the demand for personal electronics that is broadening across the industrial market. Europe is also experiencing a decline in demand, and in the third quarter, the demand for PCs and smartphones remained low. According to Canalys, the global smartphone market fell 9% year-over-year in the third quarter of 2022 - the third consecutive decline and the worst third quarter since 2014. Furthermore, Gartner reports that worldwide PC shipments fell 19.5% in the third quarter, totaling 68 million units. This is the steepest decline since the mid-1990s and marked the fourth consecutive quarter of shipment declines.
The last two years have brought significant changes for technology companies with the rise of remote working and distant learning. Mobility restrictions, social distancing measures and growing public health concerns boosted the industry's growth as tech companies relied on innovation to cater to the growing demand for digital workflows. As the world went online, employees and students splurged on smartphones and computers, and shoppers resorted to online shopping.
However, with the reopening of the economy, it is proving difficult for tech companies to maintain the pandemic-induced increase in revenue and earnings. Smartphone and computer sales are slowing globally as the economy worsens as well. Furthermore, as consumers' purchasing power deteriorates, they are cutting back on discretionary spending.
Guidance
Given the current economic situation, Texas Instruments expects revenue to fall between 1% and 9% year-over-year in the fourth quarter and earnings per share to fall between 7% and 19%.
Based on these trends, some analysts believe the company’s profit margins could suffer significantly in the coming years if economic conditions in China and other major economies continue to worsen. Texas Instruments also has significant exposure to the automotive and industrial markets, which accounted for more than half of its revenue last year. Challenging macroeconomic conditions are expected to have an impact on automotive and data center businesses in the coming year, which in return will be an obstacle for Texas Instruments .
The chip shortage may be coming to an end
The global semiconductor shortage caused by the pandemic tilted the odds in favor of chip manufacturers as demand far exceeded the supply of semiconductors. This anomaly helped Texas Instruments see margin improvements. The company serves the industrial market, and based on third-quarter data, the demand for chips in this sector is declining rapidly, bringing the market into equilibrium. Although demand for chips still seems to exceed supply in the automotive sector, things could turn around in the coming quarters as automakers look to curb spending in light of the recession woes expected next year.
The company’s strengths
Texas Instruments is one of the few semiconductor companies that has historically weathered market challenges well because of its strong industrial business. The company has a diversified portfolio in the analog and embedded markets, giving it a competitive advantage. Texas Instruments may well be able to weather the industry's ongoing "dark winter."
Additionally, its shareholder distributions make the company more attractive to income and value investors. The company has raised the dividend for 19 consecutive years so far, which goes on to highlight that its business is not as cyclical as some of its semiconductor peers. The dividend yield sits at 2.68% as of this writing.
Texas Instruments manufactures its analog chips in-house and has a strong U.S. manufacturing footprint, unlike most of its fellow U.S. semiconductor companies, allowing it to benefit from the CHIPS Act, which aims to boost semiconductor manufacturing in the U.S.
As the leader of the analog semiconductors market in the U.S., Texas Instruments enjoys competitive advantages stemming from its proven expertise and switching costs. For a client, it would be difficult to replace Texas Instruments with a competitor’s product as it requires substantial investments, expertise and time to change the architecture of an electronic device.
Takeaway
Texas Instruments showed consistent growth in the last couple of years. The guidance for the fourth quarter indicates that there could be a significant slowdown in growth in 2023. The industry is grappling with the slowing demand for PCs and declining disposable income around the world. However, the company benefits from its exposure to the industrial sector. An industry-wide slowdown in the demand for chips will negatively affect Texas Instruments in the coming quarters, but I believe the company has what it takes to recover due to its strong competitive advantages.
