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Morningstar | TI Braces for a Chip Cyclical Downturn Due to Sluggish Demand in China; Maintain $106 FVE. See Updated Analyst Note from 23 Jan 2019

Texas Instruments reported predictably soft fourth-quarter results and provided investors with a gloomy first-quarter forecast, primarily due to macroeconomic concerns and weak semiconductor demand in the Chinese market, with management citing trade tensions as an ongoing problem. TI should see its fifth straight quarter of declining year-over-year growth as the chip industry cycle is fully entering a downswing. Yet we continue to view these cyclical downturns as long-term buying opportunities in high-quality, moaty chipmakers such as TI, as we fully believe that the company will weather the latest economic storm. We maintain our $106 fair value estimate for wide-moat Texas Instruments and view shares as modestly undervalued, although we see an even wider margin of safety today in the firm's rival, Microchip Technology.

Revenue in the fourth quarter was $3.72 billion, down 1% year over year, down 13% sequentially during the seasonally soft December quarter and below the midpoint of the firm's prior guidance of $3.60 billion-$3.90 billion as discussed in October. Analog chip revenue rose 4% year over year, with TI citing strong demand for 5G signal processing and power management parts, but embedded chips (with less exposure to 5G) fell 12% year over year with a broad based decline in demand from industrial and automotive customers. We believe that longer-term secular tailwinds around rising chip content per car and industrial device are intact, but that TI's Chinese customers faced lower local end demand and reduced exports.

For the March quarter, TI expects revenue in the range of $3.34 billion-$3.62 billion which, at the midpoint, represents a decline of 6% sequentially and 8% year over year. TI stated its intentions to be prudent on capital expenditures and inventory buildups in the near term and we expect this exemplary management team to navigate through the poor demand environment in the short term.

We anticipate that TI's gross margins for the March quarter may decline to the 64% range, versus 64.8% in the December quarter and 65.8% in the September quarter. We note that days of inventory on hand rose 18 days to 152 and sits at higher-than-desired levels, per management. While analog chipmakers that run their own fabs like TI may face operating deleverage and near-term pain during cyclical downturns, chipmakers are also often early in seeing green shoots when demand picks back up. In the meantime, well-managed firms like TI are often able to be prudent on operating expenses, inventory and capital spending in order to weather the downturns. Finally, given TI's exceptional capital returns policy of distributing 100% of free cash flow to shareholders via dividends and buybacks, the company might be a willing buyer in the event that the company's stock were to sell off further during the downturn.