The Ratings Game: Why chip stocks are falling despite semiconductor shortage, strong early earnings

Texas Instruments sales suffered an 11% year-over-year decline in the second quarter of 2020, but sales have grown year-over-year each quarter since and reached 41% growth in the second quarter of 2021. Yet, Texas Instruments forecast sales growth of 25% at best for the third quarter, and refused to speculate on what would come after that.

The question of why the chip maker would forecast decelerating sales growth when strong chip demand is widely expected to last well into 2022 was center stage on Wednesday night’s conference call with analysts and in notes released Thursday. In the call, executives kept pushing back that the past few quarters of strong growth had been unusual given the COVID-19 pandemic, and that they did not want to speculate on how long that demand would last. In response, analysts called the forecast “meaningless” and “nonsensical” Thursday.

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Texas Instruments is one of the first major chip makers to report earnings this season, so similar reports could cast a pall over a sector that experienced a rough end to the last demand spike.

In 2018, the chip industry, on the whole, was on fire with stocks at record highs and increasing chip prices driving record sales. Those rising prices led many customers to double- and triple-buy chips before prices got even higher. The buying practice was so widespread that suddenly, late in 2018, demand ground to a halt, and chip makers were saddled with a glut of inventory that took several quarters to unload.

Chip makers and manufacturers have been pushing to increase supply, which could lead to a similar issue. For instance. Texas Instruments is buying a fab from Micron Technology Inc.
MU,
-2.15%
for $1.5 billion to increase chip-making capacity.

Analysts for the most part walked the conservatism off in Thursday notes as something Texas Instruments just does. Citi Research analyst Christopher Danley, who has a buy rating and a $220 price target, called Texas Instruments’ report a “wash, rinse, repeat,” affair in that the chip maker turned in stronger-than-expected results and offered a conservative outlook “as usual.”

Danley looked at the past six quarters of results and found the company has guided 5% below seasonality on average while beating its guidance by 9% on average. He expects the same to happen in the third quarter.

Given that Texas Instruments does not break out end-market sales, Danley estimates 20% of revenue is from auto customers, 37% from industrial ones, and 27% from personal electronics. Texas Instruments breaks revenue out into sales of analog electronics, which convert real-world data such as sound or temperature into digital data, and embedded processors, which take that digital data and use it to perform specific tasks.

Raymond James analyst Chris Caso, who has an outperform rating and a $230 price target, was even more blunt, calling it “another puzzling earnings report.”

“Revenue for the quarter significantly beat guidance, but it guided revenue flat, without much explanation for the conservative guidance,” Caso said. “As a result, we now consider the guidance to be meaningless. Our view is that management likely suffers from a lack of confidence at the macro level, despite what clearly continues to be tight supply conditions at both TI and the semi industry at large.”

Jefferies analyst Mark Lipacis, who has a buy rating and a $220 price target, estimates that 19% of Texas Instruments revenue comes from sales to auto makers while 44% comes from industrial customers and 23% from personal electronics makers. Lipacis acknowledged details of the report without much comment and reiterated his long-term positive outlook for the chip industry and Texas Instruments.

Lipacis called Texas Instruments an “analog renaissance beneficiary” over the next five years, in that those analog sensors play heavily into internet-of-things, or IoT, devices “which will ship in the 10s of billions of units.”

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Bernstein analyst Stacy Rasgon, who has a market perform rating and a $180 price target, has commented before that chip demand, especially CPUs for laptops, is showing signs of peaking.

“The nature of the outlook and Texas Instruments’ tone is likely to continue fueling worries over an (eventual) peak, and we note guidance, while OK on an absolute basis, was the farthest below seasonal that we have seen so far this cycle,” Rasgon said.

Rasgon picked up a point that many other analysts recognized, that Texas Instruments’ stock buybacks were lower than expected at $146 million over the quarter, suggesting that management didn’t think the stock was a good value.

“Overall, while we continue to admire how cleanly Texas Instruments sticks to their strategy, it is hard not to wonder somewhat about the setup from here, with the company likely more exposed than others to over-shipment risks, with headwinds to gross margin and [free cash flow] likely on the way, and with a valuation that remains elevated,” Rasgon said.

Evercore ISI analyst C.J. Muse, in a note titled “You get what you give,” called the conservative guidance “nonsensical.” Muse has an in-line rating and a $200 price target on the stock.

“Potentially this reflects TI just normalizing for outsized returns over the past 3 years or building a cash position for M&A, but could also highlight that TI is now trading at less of a discount to its internally calculated intrinsic value vs recent history — thus, if TI doesn’t want to buy its shares, why should we?” Muse said.

UBS analyst Timothy Arcuri, who has a neutral rating and a $195 price target, suspects that Texas Instruments management may have been reticent on details because the company “has a greater portion of its product on consignment.”

“While it didn’t call this out as a major factor, we have heard examples of customers holding back with Texas Instruments because of lack of availability of other components to complete a kit,” Arcuri said.

Of the 32 analysts who cover Texas Instruments, 14 have a buy rating, 13 have a hold rating, and five have a sell rating, according to FactSet, with an average price target of $203.91.