Wednesday, June 17, 2009

Texas Instruments (NYSE:TXN): Upgraded to Buy at Merrill Lynch/BAM - Margin expansion on Steroids

Merrill Lynch/BAM is out with a major call on Texas Instruments (NYSE:TXN) upgrading their rating to Buy from Underperform and adding the stock to their U.S 1 Focust list with a $27 tgt (prev. $18).

Firm notes their more favorable view is based on an expectation of margin expansion well above that currently being forecasted by the Street, suggesting a CY10E EPS power of $1.40+ (Street : $1.15) even against the backdrop of a modest cyclical recovery. Their new PO of $27 reflects 16x CY10 FCF/share est. of ~$1.70.

Margin expansion on steroids
Specifically, Merrill's analysis suggests: 1) an ~850bp benefit to GMs, from current levels, due to improved factory loadings, 2) an ~150bp benefit from restructuring, 3) an ~150bp benefit from lower depreciation and 4) an ~50-100bp benefit from improved mix, suggesting a GM run rate of ~52% by 4Q10 even with a modest recovery in sales next year (Street: +4% Y/Y). When combined with the benefit to annual op-ex by 4Q09 (and est. $550m) in the wake of restructuring actions, they conservatively estimate a quarterly EPS run rate of $0.43 by Q410 vs. the Street est. of $0.31. Additionally, they est. potential peak EPS at $2.30-$2.40, suggesting significant upside to the stock from current levels.

Basebands: Is the bark worse than the bite?
While there remains a significant focus on the impact to revenue from a declining baseband business over the next 3 yrs, the firm thinks the perception is worse than the reality. Their view is based on the belief that 1) much of the decline has already run its course (basebands down to ~12% of sales in 2009, from ~25% at the peak) suggesting a diminishing incremental drag; 2) the Nokia 3G business (>50% of baseband sales) is likely to recover from depressed levels with even a modest recovery in handset sales, and is unlikely to be at risk until alternate suppliers (QCOM, BRCM) begin to ramp in late 2010; and 3) the headwind from a decline in basebands is implicitly modeled into Street estimates (sales up only 4% in 2010, and 1% in 2011), as opposed to simply being factored into Street expectations.

Notablecalls: This is a fairly strong (out-of-consensus) call from a tier-1 firm.

Texas ain't exactly a momo favourite but I think it can trade into $21.50-$22 range today.

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