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%).