Texas Instruments Sticks to Guidance but Cell-Phone Doldrums Threaten

The chipmaker, which is watching its customers get hammered, also has a suspect P/E ratio.
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Cell-phone makers and their suppliers were busy last week issuing warnings that revenue would be weaker than expected this quarter. But one name was notably absent from that list:

Texas Instruments

(TXN) - Get Report


The Dallas-based company is one of the world's largest suppliers to cell-phone makers, but it's sticking by its prior guidance, which calls for revenue to fall about 20% in the second quarter from the first quarter.

But even if TI can live up to its own expectations, at these prices, the stock may not be worth it. It trades at a hefty forward price-to-earnings ratio, meaning investors' expectations are awfully high.

And yet the company isn't immune to the problems facing cell-phone makers, something that's evident from its falling revenue. This is the third quarter in a row that revenue will decline -- in the first quarter of 2001 revenue fell by 17% from the fourth quarter, which was already down from the third quarter.

Look Around

All around it there's trouble. One of the companies that warned last week was


(NOK) - Get Report

, a large TI customer. Another was

ST Microelectronics

(STM) - Get Report

, which also makes chips for Nokia. It says revenue will fall 17% to 19% in the second quarter from the first, not the 6% to 14% it previously anticipated.

TI itself says business remains very soft, and the company hasn't given guidance for the year's second half.

Down but Not Cheap
Texas Instruments stock has trailed the Philadelphia semiconductor index this year, but its P/E remains at steep levels

All this is weighing on the company's shares. Since Nokia warned on June 12, Texas Instruments' stock has slid about 13%. And since the beginning of the year, the shares have lost about one-third of their value. The

Philadelphia Stock Exchange Semiconductor Sector Index

, meanwhile, has fallen 7% since the Nokia warning and has risen 6% since the beginning of the year.

But it may not have fallen enough. A quick look at the company's price-to-earnings ratio shows that Texas Instruments is trading at levels far above other companies in its sector.

With earnings due to come in at 34 cents a share in 2001 and 66 cents a share in 2002, according to

Thomson Financial/First Call

, TI trades at a 2001 P/E of 90 and 2002 P/E of 47. That's far above the price-to-earnings multiple of, say,

Analog Devices

(ADI) - Get Report

, which also makes analog chips and digital signal processors for cell phones. It trades at 31 times estimated earnings for the year ending November 2001 and 29 times fiscal 2002 earnings. For a slightly different perspective, compare TI to its customer Nokia, which trades at about 32 times 2001 earnings and 25 times 2002 earnings.

If TI's stock stays at its current levels, its P/E ratios are likely to become even more exaggerated as Wall Street analysts continue to lower their earnings estimates.

Prudential Securities

, for instance, recently reduced its earnings expectations to 24 cents from 35 cents for this year and to 30 cents from 55 cents for next year. At the same time, in a research note, Prudential said that Texas Instruments remains one of its favorite long-term stories. (Prudential hasn't done underwriting for Texas Instruments.)

Just a Trim

Scott Randall, an analyst at

Wit Soundview

, also trimmed his earnings estimates on the company last week to 32 cents from 34 cents a share for 2001 and to 64 cents from 69 cents a share for 2002. But he maintained his strong buy rating and $46 target price for the stock. (Wit hasn't done underwriting for Texas Instruments.)

Randall says that trying to determine valuation in the short term by using its P/E doesn't work because the unusually large inventory of cell phones and chips has depressed profit margins.

Last summer, phones began to outstrip customer demand, in part because phone-replacement sales didn't go as planned. That was further complicated by the macroeconomic decline and softening consumer demand. Inventories of both phones and chips are still far from depleted. For instance, in an effort to balance supply and demand, TI is temporarily shuttering two chip plants in July. And with new cell-phone technology designed to allow users to surf the Internet more easily slow in coming, the short-term outlook is weak.

For valuation, Randall says he looks at the company over a five-year time period using a revenue growth rate of 20% to 30%, as well as an improvement in profit margins from 43% at the end of March to back above 50%, where they were last summer. In fact, as margins improve, he says, "earnings will be outpacing revenues at some point in the future."

Given the stock's P/E, investors better hope that's right.