This Stock Looks Expensive Ahead of Earnings

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Wall Street is filled with companies that have great brands and solid market positions. Then again, for one reason or another some of these same companies are always playing catch-up within their own sector. Texas Instruments (NASDAQ: TXN) serves as a perfect example.

As rivals are ramping up product portfolios and positioning themselves for a market recovery, Texas Instruments is stuck figuring out ways to reverse its revenue slide, which has now raised valuation concerns. Ahead of the company’s Q4 earnings report, investors want answers to rising inventories and strategies for securing more business. Let’s first take a peek back at Q3.

Where Texas Instruments Is Today

Despite an underwhelming 2012, shares are trading at near 52-week highs – remarkable if you ask me. Although the company beat EPS and revenue estimates, Q3 marked the fourth consecutive quarter of revenue declines – causing anxiety about its growth prospects.

Then again, 31% EPS growth was impressive – helped by 2 point sequential improvement in gross margins. Likewise, operating income advanced 3% year-over-year and 40% sequentially. As good of a performance this might have been, the company itself didn’t seem all that excited about its business. Rich Templeton, the company’s CEO had this to say about what lies ahead

  • "TI revenue grew sequentially and operations were well executed even though the economy and semiconductor market remained weak and likely will get weaker in the fourth quarter."

Well, yes and no. While Templeton was the correct in his descript of the economy, but there was also the assumption that the entire sector would disappoint. That was not the case. Take Qualcomm (NASDAQ: QCOM) as an example. In its most recent quarter, not only did revenues soar 18% year-over-year to $4.87 billion, but the company reported a 1% jump in chip shipments.

Essentially, Qualcomm was growing while the majority of the sector including Texas Instruments was revising lower. What’s more, Qualcomm is poised to have a bigger year in 2013 since management recently raised revenue guidance. It then begs the question, why is Texas Instruments trading at a P/E ratio that is 4 points higher than Qualcomm (P/E of 22 vs. 18)?

Likewise, another TXN rival Broadcom (NASDAQ: BRCM) seems to be doing ok and is the midst of becoming a remarkable turnaround story. As with Qualcomm, Broadcom continues to beat estimates with each announcement, including posting over $2 billion in revenue in its most recent quarter - a company record. This was also a 9% jump year-over-year.

Also working in Broadcom’s favor is that it has close ties with both Apple and Samsung. What this means is that Broadcom has a combined 50% exposure to the smartphone market - an advantage that some of its peers don't get to enjoy, not even Texas Instruments.

Expectations for Q4 Heightens Valuation Concerns

However, despite the performance gap between Qualcomm and Broadcom, Texas Instruments is still given the benefit of the doubt as evident by its valuation. But how long are investors going to wait? In Q3, Texas Instruments projected Q4 earnings to arrive in the range of 23 cents to 31 cents - much lower than consensus estimates of 42 cents.

The company guided revenue to come in between $2.83 to $3.07 billion, which is much lower than Street estimates of $3.24 billion. However, there might be an upside surprise in the report. Consider that two of Texas Instruments biggest customers are Nokia and Research in Motion (NASDAQ: BBRY). Texas Instrument’s struggle has paralleled their respective declines.

 However, that both Nokia and RIM have seen a slight resurgence certainly bodes well for Texas Instruments’ performance. And there’s a chance it may continue. For instance, in RIM’s fiscal third quarter, the company reported a net loss of 22 cents per share on revenue of $2.7 billion, beating Street revenue estimate of $2.6 billion.

Likewise, RIM’s loss of 22 cents was narrower than estimates of 35 cents. This is certainly encouraging despite the fact that these numbers had previously been revised lower. But what should interest investors of Texas Instruments is that RIM shipped 7 million smartphones and roughly 255,000 BlackBerry PlayBook tablets during the quarter.

How much this helps Texas Instruments’ revenue remains to be seen. But it certainly can’t hurt that RIM seems to be turning the corner. And any traction that BB10 can gain when it is announced by RIM at the end of the month will only help Texas Instruments. What’s more, investors can point to Intel’s (NASDAQ: INTC) numbers as a sign for things to come.

For Intel, the Street was looking for earnings per share of 45 cents on revenue of $13.53 billion. Intel posted revenues of $13.477 billion – arriving at the midpoint of its own guidance and missing estimates by less than 1%. But with EPS coming in at 48 cents, Intel beat Street estimates by 3 cents. This makes it an interesting comparison.

While the Street expects virtually nothing from Intel as evident by its P/E of 9, everyone thinks the world of Texas Instruments since it trades at 3-times Intel’s valuation. Again, unless Texas Instruments is “instrumental” in its performance, I still have to think the shares are expensive. What’s more, it has to significantly outperform both Qualcomm and Broadcom for it to remain a buy – at least on a relative basis.

Bottom Line

If shares of Texas Instruments were not trading at such a premium, it would be just another stock. But that’s not the case. Therefore, it draws this type of attention. As noted, while Texas Instruments still has a solid position in the market, I worry that the company may not have enough ammo unseat nimbler rivals while averting margin pressure.

Besides, I want to see that the company is able to undo the trend of fallen orders and high inventories. Until it can demonstrate this, I would shy away from the stock and look to establish positions in Qualcomm, Broadcom and a potential turnaround candidate in Intel.

rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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