TXN: Market Excited About Texas Instruments Results, We’re Still Skeptical

From William Trent, CFA of Stock Market Beat

When we previewed the earnings report for Texas Instruments (TXN – Annual Report) we said “March and June quarters have both had significant downward revisions. Will day of reckoning be forestalled?” Judging from the market’s reaction to the company’s earnings report, it appears that it has.

TI Reports 1Q07 Financial Results:

Texas Instruments Incorporated today reported revenue of $3.19 billion for the first quarter of 2007. Revenue declined 8 percent compared with the prior quarter and 4 percent compared with the year-ago quarter. Revenue was impacted by an inventory correction in the semiconductor market.Earnings per share (EPS) from continuing operations were $0.35, a decline of $0.10 from the prior quarter. The fourth quarter of 2006 included a benefit of $0.05 from the reinstatement of the federal research tax credit and a benefit of $0.01 from catch-up payments associated with new patent license agreements.

Consensus expectations called for $0.31 on $3.15 billion in revenue – which was exceeded on the top line but not the bottom after adjusting for the one-time benefits. However, guidance appears to be solid as well. The street was expecting $0.37 on $3.35 billion next quarter. The company’s guidance:

For the second quarter of 2007, TI expects revenue to be in the following ranges:

Total TI, $3.32 billion to $3.60 billion;
* Semiconductor, $3.14 billion to $3.40 billion; and
* Education Technology, $180 million to $200 million.
TI expects earnings per share to be in the range of $0.39 to $0.45.

This time it looks like the mid-point of guidance is below current expectations, but the earnings per share are well above. The company reduced its guidance for research and development spending by $100 million. Since we think the semiconductor industry overall has been investing too much in growth initiatives that never materialize we don’t mind a modest (less than 5%) reduction in that plan. The company is also spending less on capital investment, a policy of which we approve:

Capital expenditures were $179 million. This was a decrease of $35 million from the prior quarter and a decrease of $229 million from the year- ago quarter due to lower expenditures for semiconductor manufacturing equipment.

However, we are not so sure about some of the positive comments from management.

“We believe the inventory correction that began in the second half of last year largely ended in the first quarter,” said Rich Templeton, TI president and CEO.

Inventory corrections don’t typically happen all in one quarter. And while TI’s inventory declined during the quarter, the days inventory on hand rose both sequentially and on a year/year basis. The sequential decline was because sales declined faster than inventories. The year/year growth was because inventories grew and sales declined. Those do not sound to us like indications that an inventory correction has run its course.

Cash flow from operations was $554 million. This was a decrease of $292 million from the prior quarter due to increased cash needed to meet working capital requirements, such as payment of profit sharing and bonus related to 2006 performance, as well as lower net income.

With a $43 billion enterprise value before the ebullient after-hours trading, Texas Instruments was valued at nearly 40x its trailing free cash flow. If the company is correct and the inventory correction is over, the shares appear richly valued. If we are correct and the inventory correction has farther to go, the shares appear exorbitantly priced.

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