National Semi (NYSE:NSM): Upgraded to Buy at Citigroup; $23 target established

Citigroup is out with a major call on National Semi (NYSE:NSM) upgrading it to a Buy from Hold with a $23 price target (prev. $18).

National is a strong power management vendor whose management executed well last cycle by divesting non-analog product lines and strengthening its analog product offering. Profitability gains from F04-F08 were impressive, with gross margin ascending to 64% from 50% and operating margin increasing to 25%- 30% from 10%-15%. NSM’s significantly higher gross margin structure last cycle created investor concern regarding future revenue growth prospects. This concern, coupled with immature new product growth initiatives, has created overly negative stock sentiment. Within this context, Citigroup chooses to upgrade NSM for the following four reasons:

1) sector-low investor sentiment and lagging performance should reverse as leverage becomes apparent;

NSM’s 7 out of 23 (30%) Buy ratings now represents the lowest Buy mix in our analog group while its 4 out of 23 (17%) Sell mix is the second highest within the group. Furthermore, sponsorship in the name appears weak, with no upgrades post 9/10/09 earnings despite NSM delivering strong results.


2) stock offers sector-leading gross margin expansion in C10E;

NSM’s fab closures at its China (completed F1Q10) and Texas (targeting F1Q11E) facilities will drive gross margin benefits of ~100bps ($15M annually) and ~400bps ($60m annually), respectively. These fab consolidations along with other cost saving actions will enable NSM to achieve +570bps gross margin expansion in C10E. This positions NSM behind only IRF (+836bps in C10E) and significantly above the analog group average of +326bps GM expansion in C10E.


3) industrial end market, at 40% sales, is underappreciated, in firm's view, and a C1H10 driver based on seasonality and lagging cyclical improvement; and

With ~40% of sales from Industrial, NSM has the 3rd highest exposure in analog group, behind only ADI(~50%) and LLTC (~50%). Recent analog company commentary has indicated a pickup helped by US and European improvement as well as ongoing Asian industrial demand. Notably, the four companies in group with the largest industrials exposure (ADI, LLTC, MCHP, NSM), as a group, have lagged the sector in stock performance over the last three quarters to date by 2.6% (1Q09), 14.2% (2Q09), and 5.2% (3Q09QTD). Citigroup expects this trend should reverse near-term with the expected uptick in industrial activity through C1H10E.

4) fears of share loss to TXN in handsets look overblown, with smartphones a substantive catalyst through next year.

NSM has lagged analog sector performance over the past 6 months in part due to prevalent negative sentiment concerning share loss in wireless to TXN at its largest handset customer, Nokia (11% of sales in FY08). Share loss sentiment appears overblown as growth appears to have stabilized in mid-2009 after experiencing a fall-off in 4Q08. To be clear, Citigroup does see NSM having lost some share to TXN but this has been mostly within lower-end handsets. More importantly,they still see NSM well positioned within the highend
multi mode/feature rich phones.


Citigroup increases F2010E EPS (GAAP) to $0.60 from $0.56 and F2011E EPS (GAAP) to $1.00 from $0.72. Their F10/11E EPS (GAAP) are $0.60 / $1.00 vs. Street’s $0.56 / $0.88.

For F2Q10, they edge up EPS by $0.01 to $0.14 on a 0.7% higher sales assumption of $340M versus $338M. Firm's 2Q revenue estimate implies 8.1% qq growth, is 1.7% above the Street, and marks the top of NSM’s $325M- $340M guidance range.

Notablecalls: This is one gutsy call from Citigroup and will likely get the attention of traders starting from early on.

I see this one trading up 3-5% over the day.

The only problem here is the general market. If the market continues to roll over (as witnessed post FED announcement yesterday) the buyers of the NSM upgrade are going to look silly. That makes NSM a kind of a market bet. I personally dislike these.

Dennis Gartman notes this morning:

'... Today, then, shall be a very important day for the stock market here in the US and then abroad, for if the “reversals” are to be denied, the markets shall have to stabilize and push higher. If we were to open firmer and then fail, the technical damage wrought would be quite serious indeed. As we write, the futures are all trading rather markedly lower, and that means perhaps a “gap” to the downside right from the outset. Let’s please have our protective hats on and have chin straps tightened; this might get ugly!...'