Does an industrial recession ruin Texas Instruments’ long-term plans?
Many think of Texas Instruments (TXN -1.44% ) as the ultimate indicator for the semiconductor industry as well as for the technology and wider sector. As such, many tech and chip peers sold hard last week after TI published weak results in the third quarter and gave even worse indications for the fourth quarter. In fact, the fourth quarter guidance was up to $300-500 million lower than analysts’ revenue estimates, and a whopping 16% to 29% lower than consensus estimates for earnings per share.
In fact, the forecasts were so bad, and so far below already muted expectations, that analysts rushed to management, looking for answers. This led CFO Rafael Lizardi to say:
I can sense that you are collectively dissatisfied with our responses, and I understand that. We have nearly 100,000 different customers and we sell about 100,000 different products. It’s hard to pinpoint anything in particular, but the impression we get talking to those customers who get feedback from them, from our salespeople, and from all the touchpoints we have, is that the weakness is widespread, is due to macro events, and more specifically trade tensions.
Analysts may have been relatively shocked because last week another big tech chip indicator, Semiconductor manufacturing in Taiwan (TSM -4.85% )job very strong numbers due to higher than expected demand for 5G chips.
If you are invested in hardware space, these two income reports could be the source of some cognitive dissonance. So what exactly is going on here?
Texas Instruments bet on the wrong horse for 2019
The difference can probably be explained by the focus on different end customers. Taiwan Semiconductor manufactures a wide range of chips for end customers, including CPUs, GPUs, FPGA chips, and other chip systems used in a wide range of applications. At a high level, however, Taiwan Semi is highly concentrated in two hot subsectors. It got nearly half of its revenue from smartphones last quarter, with another 29% coming from high-performance computing, essential for growing industries like gaming and artificial intelligence. While the tech sector is experiencing a major slowdown, 5G applications were a distinct bright spotas US and Chinese companies vie for leadership.
In contrast, Texas Instruments produces analog and embedded chips for a wide range of electronic applications. These range from household appliances to medical devices, aerospace and defense, and other industrial equipment. In particular, Texas Instruments made its biggest bets in the industrial and automotive sectors of the market. According to its 2018 annual report, Texas Instruments earned 36% and 20% of its revenue from the industrial and automotive sectors, respectively. While management still maintains that these two markets are the most attractive long-term sectors for analog and embedded chips, that bet looks bad in 2019.
An “industrial recession”
The U.S.-China trade war and associated tariffs wreaked havoc on industrial and manufacturing output in 2019. Recently, the Institute of Supply Management’s Purchasing Managers Index, which measures the U.S. industrial activity, contracted for the second consecutive month to its lowest levels since 2009, in the depths of the Great Recession. Of particular concern is Germany’s large manufacturing sector, which many believe is currently in the midst of a recession.
An industrial slump might seem like a bit of a stretch – after all, the overall economy still seems to be growing and some companies have again released strong numbers this earnings season. However, the manufacturing sector only accounts for around 12% of US GDP, so it is entirely possible that although US consumer spending has remained strong, the manufacturing sector is actually in recession. It’s just that many haven’t felt the effect…at least not yet.
Adding to an industrial slump, auto sales were down about 2% from a year ago through the end of the third quarter, although some car brands were down much more than that. Moreover, the recent strike of General Engines probably doesn’t help matters.
Management still believes
On the conference call with analystsmanagement said: “We remain focused on industrial and automotive, the top markets, which will be the fastest growing semiconductor market as they have increasing semiconductor content and also offer diversity and longevity. All this translates into a high terminal value of Our portfolio.”
It is true that both internet of things and increasingly connected autonomous vehicles will drive more semiconductors in factories and automobiles in the years to come. However, these two major sectors are in great difficulty at the moment. While Texas Instruments may end up looking smart in the long run, for at least 2019, the year of the trade war, it looks like TI has made a losing bet.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.