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Morningstar | TI's 4Q Forecast Points to a Softer Market, but We Like the Long-Term Buying Opportunity

Texas Instruments reported third-quarter results that were relatively in line with our expectations, but the company provided investors with a soft fourth-quarter forecast that indicated that a semiconductor industry downturn is on the horizon. TI believes it is "heading into a softer market," and although the firm hesitated to explicitly call out tariffs or trade wars or weak demand from a single region for such softness, the firm noted that demand slowed across most of its businesses during the third quarter while forecasting flattish year-over-year sales in the fourth quarter. We will maintain our $106 fair value estimate for wide-moat TI. We see the recent sell-off in semis as the start of an attractive margin of safety for long-term investors as moaty companies, such as TI, know how to weather the upcoming industry storms. While we view TI as undervalued, a top pick of ours is TI's rival, Microchip Technology, where we see an even wider margin of safety for investors.

TI's third quarter revenue was $4.26 billion, up 6% sequentially and 4% year over year but just missed the midpoint of the firm's prior forecast of $4.28 billion as demand slowed across most of its businesses during the quarter. Industrial chip sales growth slowed to a high-single-digit pace year over year, versus double digits in prior quarters, while automotive chip sales rose at a double digit pace year over year but again decelerated. Analog chip sales grew 8% year over year while embedded chip sales fell 4% year over year due to lesser demand for processors used in communications equipment. Nonetheless, gross margins still rose 60 basis points sequentially to 66%.

For the fourth quarter, TI expects revenue in the range of $3.6 billion-$3.9 billion, which, at the midpoint, would represent flat year-over-year sales growth and a 12% sequential decline, worse than the typical weakness TI normally sees in the December quarter (a high-single-digit decline, on average).

TI has managed through cyclical downturns in the past and we think the firm is well poised to do so again. The company noted that it will reduce wafer starts and be prudent with some aspects of SG&A but will continue to invest in other SG&A areas, as well as R&D, in order to drive long-term growth in strategic areas. The firm also appears ready to invest in additional 300 millimeter wafer manufacturing capacity in 2020 and beyond and note that the company's investments in this area a decade ago paid off quite handsomely in terms of meaningful gross margin expansion.

The company was quite hesitant to cite a single factor as contributing to the recent slowdown in chip orders, but weak auto sales and industrial earnings reports in recent weeks all point to the effects of tariffs and a trade war between the U.S. and China. TI did note that chip inventory at distributors, as well as order cancellations, still appear relatively normal so the sky doesn't appear to be falling in the analog chip market just yet. Nonetheless, the long-term trends of rising chip content per product in automotive and industrial still appear intact and we remain bullish on TI's ability to profit from these trends over the next five to 10 years. While we are more bearish on TI's 2019 results, we anticipate a snapback in demand thereafter, and our revenue and EPS estimates for TI in 2020 and beyond remain relatively unchanged.