Summary
- A clear, consistent priority to grow free cash flow per share.
- Dealing with commoditization and semiconductor cycles.
- Industrial, automotive, IoT, 5G, 8% compound revenue growth.
- Trade, tariffs, China and security risks.
Our SWOT analysis are meant to serve as a baseline for doing research on companies that we might invest in at certain prices. As Warren Buffett has repeated many times, only by getting to know a company’s business, can we start to understand whether or not to invest our hard earned money.
Introduction
Texas Instruments Incorporated (TXN) makes semiconductors at facilities in North America, Asia, Japan and Europe for electronics designers and manufacturers. TXN operates in more than 30 countries through two reportable segments: Analog and Embedded Processing. 2018 revenue was $15.78 billion from 100,000 customers, with $10.80 billion (68%) from Analog and $3.55 billion (23%) from Embedded Processing.
Analog product lines include Power, Signal Chain and High Volume. Analog semiconductors amplify and convert signals, such as sound, temperature or pressure into digital data. Analog semiconductors manage power in electronic equipment by converting, distributing, storing, discharging, and measuring electrical energy. Some of the larger markets are industrial, automotive and personal electronics.
Embedded processors are the “brains” of many types of electronic equipment, designed to handle specific tasks, from simple, low-cost microcontrollers in electric toothbrushes to highly specialized, complex devices used in automotive infotainment systems and advanced driver assistance systems, or ADAS. Two major markets for Embedded Processing products are industrial and automotive.
Other 2018 revenue was $1.43 billion, including high definition projectors, calculators and application-specific integrated circuits, or ASIC.
In 2018, operating profit was $6.713 billion, with Analog contributing $5.11 billion, Embedded Processing $1.21 billion, and $399 million from Other.
Strengths
Management consistently delivers strong results from clear priorities. TXN carefully monitors the pulse of its customers. With a long history (founded in 1930) and extensive data, they manage inventory for maximum effectiveness. Capital allocation decisions are driven by the goal to grow (and return) free cash flow per share.
- Management is laser focused on growing free cash flow. TXN’s stated goal is to return at least 100% of free cash flow per share to shareholders through dividends and share buybacks.
- TXN offers a broad array of semiconductor products. Some are low-cost commodity-type products available from their catalog and some are advanced products developed for specific customer applications. Each year, TXN invests $1 billion in R&D and their engineers create 300-400 new products.
- TXN’s breadth and scope, plus a stream of new products has kept the company in a leadership position within the semiconductor industry. Management believes it has the best products (Analog and Embedded) in the best markets (Industrial and Automotive).
- The company has maintained financial discipline and enjoys a strong, conservative balance sheet with a Standard & Poor’s credit rating of A+.
Weaknesses
The semiconductor market sees constant, though usually incremental, advances in its products and manufacturing processes. With competition and improvements in manufacturing, costs and prices tend to decline over time. So far, TXN has managed these issues well by keeping costs down, by taking advantage of its scale, its customer relationships and by continually introducing new products.
- While Texas Instruments’ commitment to research and development has kept it on the cutting edge of technology, the company produces thousands of low-cost, commodity-like products that are vulnerable to intense competition.
- Many TXN semiconductors find their way to industrial, automotive and personal products that are subject to economic cycles. The company has effectively managed changes in the broader economy but it is not immune to economic downturns.
- In addition to exposure to broad economic swings, the semiconductor industry experiences its own sector cycles. Fortunately, these have been relatively predictable and TXN has developed considerable skill in managing production and inventory controls.
Opportunities
TXN has created a competitive manufacturing cost advantage by investing in its advanced analog 300-millimeter capacity. Each year the company invests about $1 billion in R&D. Their strong and extensive customer relationships provide a base for introducing (and sometimes co-developing) new products for and with customers. They continue to grow market share in their Analog and Embedded Processing segments.
- TXN is preparing to build a second factory to manufacture 300-millimeter silicon wafers, which cost 40% less than a chip built on the 200 mm wafers which are used by most of the company’s competitors. This will extend TXN’s technological advantage.
- Technology is interwoven into product development, which drives demand for semiconductors. Customers of TXN’s Embedded Processing products often invest their own R&D to write software to operate on TXN products. This solidifies customer relationships and makes it easier for customers to re-use software over multiple generations of TXN products.
- TXN is preparing for Analog growth in communications equipment for the Internet of Things, or IoT, by developing products for 5G macro base stations.
- TXN’s Analog and Embedded Processing segments have 5-and-10 year compound revenue growth of 8%, aided by annual market share growth of 30-40 basis points. These segments account for 90% of company revenue and TXN appears well-positioned for continued revenue growth.
Threats
The company’s broad global footprint can be an operational and marketing advantage but it opens TXN to various kinds of threats. Their 29,888 employees (as of December 31, 2018) are spread over more than 30 countries. The company has a strong history of navigating international dynamics, but global competition and risks are growing. A major concern is increased tensions between the U.S. and China.
- TXN’s stiff competition requires a response to rapid product development and pricing pressures. Competitors are large corporations, small operators in niche markets and emerging companies, primarily in Asia.
- The company is impacted by tariffs and other restrictions on international trade. About 85 percent of TXN revenue comes through shipments to locations outside the U.S. Of particular concern is heightened tension between the U.S. and China, since shipments of TXN products into China typically represent a large portion of the company’s revenue.
- With facilities in more than 30 countries, TXN is exposed to various kinds of political, social and economic disruptions, constantly evolving cybersecurity threats and other security risks such as terrorism.
- Texas Instruments can be impacted by currency fluctuations. High fixed costs associated with manufacturing facilities may cause margin compression during economic downturns.
Long-term Business Outlook
Texas Instruments has prospered through cycles in the semiconductor industry. They are well-positioned for continued growth. Management is prepared to adapt to a changing global economy and will stay focused on growing the company’s free cash flow per share.
Over the next five years, TXN should continue to successfully execute a strategy with four sustainable competitive advantages that are difficult to replicate: (1) manufacturing and differentiated technology; (2) a broad portfolio of analog and embedded products; (3) a broad reach of market channels; and (4) diversity and longevity of products, markets and customer relationships.
It seems very likely that TXN will continue to be disciplined in resource allocation to support the best product opportunities, increased efficiency and a strengthened competitive advantage.
The company is in the third quarter of a cyclical semiconductor downturn, which typically lasts four or five quarters (of year-over-year declines). TXN operates in a cyclical industry, so growth isn’t in a straight line. But over the course of multiple cycles, TXN has consistently grown its free cash flow per share and is delivering on its goal of returning at least 100% of free cash flow per share to shareholders through dividends and share buybacks. The three drivers of free cash flow per share are: (1) top line growth; (2) incremental free cash flow margin expansion; and (3) share count reductions.
Key sources:
2018 Form 10-K, February 22, 2019
Capital Management Strategy Update, February 5, 2019
4Q18/2018 Earnings Conference Call, January 23, 2019
1Q19 Earnings Conference Call, April 23, 2019
Disclosure: I am/we are long TXN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article was written by Ted Leach (Dividend Sleuth) with input from Kirk Spano and David Zanoni. The article is for informational purposes only (not a solicitation to buy or sell stocks). Ted is not a registered investment adviser. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.
