Texas Instruments Excellence

Texas Instruments (TXN) is on our Dividend Growth 30 very short list.

Texas Instruments Incorporated (TXN), also known as “TI,” is a straight-forward, cut-to-the-chase operation, so I’ll keep this simple: TI is one of my core technology positions because their effective management team consistently executes a successful business model. Without glitz or glitter, TI produces the nuts and bolts of a profitable niche in the technology sector.

In a sector replete with hype and buzz words, Texas Instruments has a boring (i.e., consistent and unwavering) focus on growing free cash flow per share. Their execution on this focus enables TI to produce steady growth in the cyclical semiconductor industry. TI’s “nuts and bolts” are highly-engineered, technologically advanced high-capacity silicon wafers and other devices.

TI is well positioned to continue to be a leader in analog semiconductors and embedded processors as 5G technology expands the possibilities for IoT, the Internet of Things

Two segments:  Analog and Embedded

TI groups its Analog sales into Power, Signal Chain and High Volume product lines. Analog semiconductors amplify and convert signals, such as sound, temperature or pressure into digital data. They measure and manage electrical energy. Major markets are industrial, automotive and personal electronics.

Embedded processors are the “brains” of many types of electronic equipment, ranging from low-cost microcontrollers in electric toothbrushes to complex devices used in automotive infotainment systems and advanced driver assistance systems (ADAS). Major markets are industrial and automotive.

The 2018 10-K indicated that revenue was $15.78 billion, with $10.80 billion (68%) from Analog and $3.55 billion (23%) from Embedded Processing.

Other 2018 revenue was $1.43 billion, including high definition projectors, calculators and application-specific integrated circuits (ASIC).

2018 operating profit was $6.713 billion, with Analog contributing $5.11 billion, Embedded Processing $1.21 billion, and $399 million from Other.

A global semiconductor leader

TI was founded in 1930 as a small oil and gas company. During World War II, the company applied signal processing technologies to submarine detection and radar. The company took the name Texas Instruments in 1951, invented the silicon transistor in 1954 and invented the integrated circuit in 1958. Both were foundational for the semiconductor industry and modern electronics. TI developed an electronic hand-held calculator in 1967. TI components were in the Apollo Lunar Exploration Module that landed on the moon.

TI impacted appliances, consumer electronics and industrial equipment with significant advancements, including:

A maze of products but a clear, simple focus 

TI offers its 100,000 customers nearly 100,000 products. It has 30,000 employees in more than 30 countries. The company has nearly 40,000 patents and it introduces 300 to 400 new products each year. 

Don’t get lost in the maze or overwhelmed by this complexity. Instead, enjoy their simple business model of growing free cash flow per share, which is almost a mantra. TI’s quarterly conference call webcasts and transcripts make clear that the business is designed around the most profitable segments in the most promising sectors for long term growth of free cash flow per share.

Capital allocation decisions about personnel, research and development, factory expansion, mergers, acquisitions, dividends and share buybacks are driven by what will enable the company to grow free cash flow per share.

Visitors to the TI website are greeted by a quote from Chief Executive Officer Rich Templeton:

“The ultimate measure for any enterprise is superior long-term growth of free cash flow.”

Free Cash Flow Graphic

(Image from the Texas Instruments website)

Dave Pahl, Head of Investor Relations and Chief Financial Officer Rafael Lizarditypically handle the quarterly earnings calls. They also presented the annual capital strategy webcast on February 5, 2019. Some key points from this presentation include:

  • “We are focused on the best products and in the best markets in the semiconductor industry. We believe analog and embedded are the best products.”
  • “We believe industrial and automotive are the best markets and will drive growth in our industry and for TI. These markets are the fastest growing due to their increasing semiconductor content, a trend that’s fueled by products becoming more intelligent, more connected, safer, more efficient, especially as mechanical and electromechanical features are replaced with solid-state electronics.”
  • “In the coming years, we believe that we will have three drivers contributing to free cash flow per share growth: top line revenue growth, free cash flow margin expansion and share count reduction.”
  • “We have now raised the dividend for 15 consecutive years, including a 24% increase in 4Q ’18. We have increased the dividend at a compounded annual growth rate of 21% over the last five years.”
  • “We have reduced shares outstanding by 45% since 2004, including the 3.9% reduction in 2018.”
  • “We remain committed to returning all free cash flow to the owners of the company.”

Steady growth in a cyclical industry

For the 12 months ending March 31, 2019, TI reported free cash of $6 billion, up 22% from the prior year. Free cash flow margin for the same period was 38.4% of revenue, up from 32.1%. In the Q1 2019 earnings call, Dave Pahl said, “We continue to benefit from the quality of our product portfolio that’s long-lived and diverse, and the efficiency of our manufacturing strategy, the latter of which includes our growing 300-millimeter Analog output.”

Several years ago, TI invested in a new factory designed to build 300-millimeter silicon chips. The company now plans to build in the next few years an additional 300-millimeter chip factory in Richardson, Texas. At the February capital allocation presentation, Dave Pahl said:

“A chip … made on a 300-millimeter wafer costs about 40% less than a chip built on a 200-millimeter wafer, the size used by most of our competitors. … A 300-millimeter wafer has 2.25x more area, which … means we get about 2.3x more chip, but it doesn’t cost 2.3x to process that larger wafer. This translates into a structural cost advantage.”

According to TI management, the semiconductor business currently is in the third quarter of a cyclical downturn. Operating profit was down 11% from the year ago quarter. Operating margin for Analog was 43.2%, down from 45.4% a year ago, and for Embedded Processing, was 31.3%, down from 35.4% a year ago.

CFO Rafael Lizardi discussed this cycle in the Q1 2019 earnings call: 

“As we said last quarter … after 10 quarters of year-on-year growth, the weakness we are seeing is primarily due to the semiconductor cycle. We have just completed our second quarter of year-on-year declines for TI. If you look at history, cycles are always different, but typically, the industry would have 4 to 5 quarters of year-on-year declines before year-on-year growth resumes. We are not trying to forecast the cycle, but simply offer some historical perspective.”

In response to an analyst’s question about how the company is approaching buybacks versus dividends, Lizardi’s reply connected the current business cycle with TI’s ever-present goal of increasing free cash flow:

“First, let me take everybody back to our capital management strategy. … our objective is to return all free cash flow to the owners of the company via buybacks and dividends. And within that, … sometimes you strategically build cash, sometimes you strategically drain cash, right? So then (at times) you can actually return more than 100% of free cash flow. As frankly, we’ve done for the last few years. But on … buybacks and dividends, the goal is to provide a sustainable and growing dividend and we target to be somewhere between 40% to 60% of free cash flow. At the moment, on the trailing 12-month basis, we’re 45%. And then on the repurchases, it’s the accretive capture of future free cash flow for the long-term owners.”

Engineering a place in our 5G, Internet of Things future

TI sees expanding Analog growth opportunity, enhanced by products for 5G, such as macro base stations. In the midst of a general semiconductor downturn, the company saw their communications equipment business grow in Q1 2019 about 30% year on year, benefiting in part from 5G shipments. 

About 60% of Texas Instruments’ research and development goes directly into product development, creating 300-400 new products a year. 

TI’s Analog and Embedded segments represent more than 90% of company revenue, combining for a compound average revenue growth rate of 8% over the past 5 and 10 years. Some of this growth is from market share gains, which have averaged 30 to 40 basis points annually for the past 15 years. TI expects Analog and Embedded to continue to drive top line growth.

Technology is driving a “smarter” future, with smart phones, smart cars, smart homes, with everything integrally connected. TI semiconductors and related solid state products will be inside such things as automobile dashboards, sensors and timers that control the environment of homes and businesses, and components that facilitate interactive communication between traffic signals and automobiles. TI will provide many of the “brain” parts for the IoT, the Internet of Things–the Connected Everything.

Financial Performance

Here’s a snapshot of selected data from Finviz.

  • Trailing 12-month Earnings Per Share: $5.51
  • Trailing 12-month Price/Earnings ratio: 20.44
  • Projected 2019 EPS: $5.77
  • Forward P/E ratio: 19.53
  • Estimated earnings growth for the next 5 years: 8.04%
  • PEG ratio: 2.54
  • Beta: 1.18
  • Book Value: $9.45

From the F.A.S.T. Graph below, except for the market decline that bottomed in December, 2018, TXN’s per share price growth has outpaced EPS growth. The market has awarded TXN a premium valuation since the fall of 2012. 

Texas Instruments’ Standard & Poor’s credit rating is A+.

Debt is indicated at 35% of capitalization. On my spreadsheet, I keep two measures of debt, one by market capitalization and one by book value. I have found the market cap comparison to be more useful. TI’s debt as a percentage of market valuation is 5.0%. (Debt is $5.8 billion and market value is $105.3 billion, for a total capitalization of $111.1 billion.) TI’s debt as a percentage of book value is 40.0%. (Debt is $5.8 billion and book value is $8.87 billion, for a total capitalization of $14.7 billion.)

F.A.S.T. Graphs projects that after a slight dip in 2019, EPS will grow at 10% in 2020 and again in 2021.

F.A.S.T. Graph

(Graph from F.A.S.T. Graphs)

Dividend

Justin Law’s compilation of Dividend Champions (25+ consecutive years of dividend increases), Contenders (10+ years) and Challengers (5+ years) includes Texas Instruments among the Dividend Contenders at 15 consecutive years of dividend increases, beginning in 2004. The list is maintained by The DRiP Investing Resource Center, which shows TI’s 5-year dividend growth rate as 19.7%. The most recent increase was 24.19%. 

I have been long TXN since January, 2016. I made three buys that month that averaged $50.10, when the quarterly dividend was $.38 and the annual dividend was $1.52. The yield at that time was 3.03%. At the $112.60 closing price on Friday, May 10, 2019, and a current quarterly dividend of $.77, or $3.08 annually, TXN’s current yield is 2.75%. The dividend has more than doubled in 3.5 years but the market price has risen even more.  TXN represents 3.14% of the market value of my retirement income portfolio.

TXN’s high yield for the past 5 years has ranged from 2.9% to 3.5%, a relatively narrow range. The average high yield has been 3.1%. 

Valuation

TXN’s 52-week price range has been $87.70 to $119.32. The mid-point of this price range is $103.51. The low price occurred during the severe market selloff on December 26, 2018. At that time the yield was 3.5%–matching the high yield for the past 5 years.

In this study of TXN, as in a recent study of Cisco (CSCO), I used a tool called The Stock Selection Guide that was developed in the early 1950s by the (then) National Association of Investment Clubs (now BetterInvesting.org). Its purpose is to establish a possible price range for a stock for the next 5 years, using selected data from the past 10 years, modified by one’s judgment about factors that may enhance or impede future growth. 

Estimated high price. I chose a potential high Earnings Per Share of $8.21, using the Finviz estimated EPS growth of 8.0% over the next 5 years. I chose a potential high Price/Earnings ratio of 23.1 (which is the average high P/E for the previous 5 years). $8.21 x 23.1 indicates a possible high price of $189.70. 

Estimated low price. I selected $80.00 as a possible low price for the next 5 years. I averaged the 52-week low of $87.70 and the January 6, 2017 low of $72.50, which is $80.10. That’s also about 10% lower than the 52-week low, which I sometimes use. 

Price range. A possible 5-year price range of $80.00 to $189.70 represents a swing of about $109.70. I divide this range into fourths, so that the lower 1/4 is a “buy” range, the upper 1/4 is a “sell” range and the middle 1/2 of the possible price swing is a “hold” range.

Buy and sell ranges. Thus, the “buy” range is $107.40 or less (up to $27.40 higher than the possible low of $80.00). The “sell” range is $162.20 or above ($27.40 lower than the possible high of $189.70).

Texas Instruments is a hold for me at $112.60. Currently, TXN is my 8th largest holding at 3.14% of the portfolio. Since I already have a sizable position, my target buy price is $96.25, which would be a 3.2% yield at the current annual dividend of $3.08.

TXN SSG Page 1
TXN SSG Page 2

(Author’s calculations using BetterInvesting.org’s Stock Selection Guide)

Conclusion

I consider Texas Instruments a core technology holding, along with Cisco and Qualcomm (QCOM). I appreciate TI’s laser focus on growing and returning free cash flow to shareholders through dividends and share buybacks. Our world is becoming more digitized, technologically more intelligent, and more inter-connected. TI’s semiconductors and related products will be increasingly important in the future. 

If you’re a TXN shareholder, or considering a purchase of TXN shares, I encourage you to visit TI.com to access archived webcasts of management presentations to analysts (particularly the February 5 “management strategy” webcast/transcript). 

Disclosure: I am/we are long TXN, CSCO, QCOM. 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) in collaboration with 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.