Over the past two months, there’s been plenty of gloomy media commentary on the software and IT sector, with suggestions that the industry is heading for another dotcom-style crash. But this is too pessimistic. Sure, times are hard and inventory levels are being cut, but turnover isn’t about to fall off a cliff. The industry hasn’t overly expanded during the past five years, at a time when the world has become far more reliant on technology to improve productivity, cut headcounts and offer new services, such as e-commerce. As such, the recent savage sell-off has resulted in some quality IT giants trading at three to five-year lows.
Texas Instruments (NYSE:TXN), tipped as a BUY by Deutsche Bank
Take Dallas-based Texas Instruments, a leading developer of microchips for mobile phones, consumer goods, cars and medical equipment. It owns more than 35,000 registered patents and its state-of-the-art technology (in fields such as power management and data storage) is used in around half of all cell phones and 75% of laptop PCs sold globally. Last week, despite a recent profit warning from its largest customer, Nokia, Texas Instruments said that performance for the current quarter was still on track, forecasting revenue and underlying earnings per share of $3.4bn and 44 cents respectively. A key reason for its resilience is that the firm has shifted towards more profitable 3G mobile devices and away from low-margin entry-level handsets. It has also ramped up its analogue (35% of sales) and embedded processor (12%) units, which are growing at double-digit annual rates.
Texas Instruments deserves a much higher rating. Wall Street expects 2008 sales and adjusted earnings per share to come in at $13.5bn and $1.81, rising to $14.0bn and $1.95 in 2009. That puts the stock on forward p/e ratios of only 12.3 and 11.4. This looks far too cheap, especially as it is also generating around $1.90 a share in operating cash flow and has a rock-solid balance sheet with net funds of $1.6bn. On top of this, due to the improving product mix and greater cost efficiencies, the board reckons that operating profit margins can be lifted from 25% currently, to 30% by 2011-2012.
There are the usual pitfalls to consider, of course. This Christmas could be tough as the economy slows and consumer spending weakens. Texas Instruments faces a variety of other challenges, including rapidly changing technology, intense competition from rivals – such as Infineon, STMicroelectronics and Qualcomm – high capital intensity (it has to spend a lot on research and development) and pricing pressure. Yet the firm looks well run and has reinvented itself many times over its 78-year history. While some of the recent changes have prompted jitters on Wall Street, the risks look weighted towards the upside. Once the worst of the downturn has passed, Texas Instruments should be in a strong position, given its great product line-up, strength in mobile computing, economies of scale and strong customer relationships.
Recommendation: long-term BUY at $22.30
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.