Without Texas Instruments (TXN), most of the world’s electronic equipment would not function. The company is an extremely important player in virtually every end market and maintains numerous competitive advantages.
Texas Instruments has also been a free cash flow machine, converting close to 30 cents of every $1 in sales into free cash flow. Not surprisingly, the company scores strongly for Dividend Safety and Dividend Growth and has paid uninterrupted dividends for more than 50 consecutive years.
Let’s take a closer look at this technology giant for our Top 20 Dividend Stocks portfolio.
Business Overview
Texas Instruments was founded in 1930 and primarily focuses on manufacturing analog chips (64% of revenue) and embedded processors (21%).
Analog chips are used in nearly all electronic equipment to monitor, amplify, transform, or regulate signals found in the real world such as pressure, light, temperature, weight, and sound. Analog chips also provide voltage regulation and help manage power usage.
Embedded processors act as the “brains” of many electronic devices and are designed to handle a variety of specific tasks in items ranging from electronic toothbrushes to automotive infotainment systems. Its major product lines include microcontrollers, processors, and connectivity products.
Texas Instruments sells into most major end markets, including industrial (31% of sales), personal electronics (31%), automotive (15%), communications equipment (13%), and enterprise systems (6%).
The company sells more than 40,000 products and adds more than 500 new products to its portfolio each year. Texas Instruments sells its products to more than 100,000 customers, and Apple was its biggest customer last fiscal year accounting for 11% of total revenue.
Business Analysis
Texas Instruments gains competitive advantages from its size and strategic focus on analog semiconductor chips.
In 2009, the company made a major decision to exit its wireless business, which represented 20% of Texas Instruments’ revenue in 2008 and primarily supplied chips used to connect cell phones to cellular networks.
Management feared the wireless business had already seen its best days and was headed on the path towards commoditization.
By exiting wireless, Texas Instruments could focus its investments on analog chips and embedded processors, which possess much faster growth potential. These two categories accounted for roughly 86% of the company’s sales last year, up from 44% of revenue in 2006.
Participating in the analog market has numerous appeals. Many analog chips go into products with long lifecycles, such as automobiles. As a result, they have a slower pace of technological change and don’t require substantial investments to maintain cutting-edge manufacturing processes and technologies. This allows analog chip companies to generate higher returns on invested capital, throw off more free cash flow, and enjoy greater stability (some products generate revenue for decades).
Since Texas Instruments is also well diversified by product and customer, it also has less risk of product obsolescence and rapid price erosion. No single customer, product, or market can take the company down.
Many analog products such as those used in industrial equipment and automotive markets are mission-critical and must last a long time. Designing these chips requires a good deal of creativity and specialized skills.
Texas Instruments has estimated that it takes at least five to 10 years of experience beyond graduate school to develop an analog engineer’s skill. When combined with Texas Instruments’ long-standing customer relationships, it’s no wonder why the company is so entrenched in its markets.
Texas Instruments also gains several advantages from its size. The company has the scale need to efficiently manufacture most of its products in-house and invested over $550 million on capital expenditures last year alone.
By owning its own factories, Texas Instruments has more control over its supply chain to support its customers and can manufacture its products more cost-effectively than its peers.
Texas Instruments build the industry’s first and only 300-millimeter wafer fab for analog manufacturing in 2010, reducing its wafer cost by 40% compared to the process used by most of its competitors. Building the 300-millimeter fab cost $8 billion and requires a massive base of customers to keep their capacity utilized, preventing smaller players from effectively competing on cost.
The company’s size also allowed it to invest approximately $1.3 billion in research and development last year. The company’s investment in innovation has helped it maintain a strong, broad-based portfolio of more than 42,000 patents.
Equally important, Texas Instruments maintains the broadest portfolio of analog chips and embedded processors in the industry. The breadth of the company’s portfolio helps it solve more needs than its competitors, giving it access to more customers and the ability to generate more sales per system.
Texas Instruments also has the industry’s largest global sales force and distribution channels, helping it provide reliable service to its customers and more effectively help them navigate the chip design process.
These factors have helped the company gain market share in analog and embedded processing for six consecutive years. Texas Instruments currently holds leading market share positions in four major categories of analog products. It is number one in amplifiers, interface, and power products and number two in data converters.
From a growth perspective, the analog and embedded processor markets are large and fragmented.
Texas Instruments believes the analog market is $45 billion in size. The company holds the number one position in the market with 18% share, providing room for continued consolidation.
The embedded processing market is roughly $18 billion in size, and Texas Instruments is again the largest player with 15% share.
Importantly, virtually every electronic device requires analog technology and most use embedded processing as well.
Some markets such as automotive are experiencing particularly strong growth as products become smarter and demand more semiconductor content. Texas Instruments is positioned to see its business continue to moderately expand as electronics become smarter and more connected.
Looking ahead, the company’s management team believes free cash flow margins can expand from about 27% to 30%.
As Texas Instruments builds more analog products at its 300-millimeter wafer fab, it will enjoy lower costs for more of its chips. Additionally, filling up excess capacity at its fabs will further increase free cash flow because incremental production carries very high margins given the amount of fixed costs in the business.
Overall, Texas Instruments appears to have a fundamentally solid business. It benefits from operating in slow-changing markets and uses its manufacturing, technology, and distribution advantages to protect its leading market share positions.
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Texas Instruments’ Key Risks
Texas Instruments can be whipped around over short periods of time. Demand for some of the company’s products can rapidly increase or decrease without any notice, resulting in occasionally volatile quarterly results.
While the stock can be impacted by unexpected shifts in demand, this really isn’t a risk that threatens the company’s long-term earnings power.
More importantly, the semiconductor industry constantly faces technological change and intense pricing competition. It is also very mature, potentially making longer-term growth more difficult.
While Texas Instruments focuses on products and markets characterized by a much slower pace of change and longer product cycles, the very nature of technological innovation is unpredictable.
The company’s financial strength and diversification by customer, end market, and product help combat this risk, but it’s worth remaining aware of.
A final long-term risk to consider is Texas Instruments’ decision to do most of its manufacturing in-house. Rather than outsource the production of its chips like many of its peers do, Texas Instruments maintains multi-billion dollar manufacturing facilities to gain cost advantages.
If the market were to experience a technological shift that makes in-house production less attractive, Texas Instruments could be stuck with a number of costly and inefficient assets.
Overall, aside from the industry’s expected cyclicality, there don’t appear to be many fundamental risks to the company’s long-term future because of its conservatism and diversification.
Dividend Analysis: Texas Instruments
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Texas Instruments’ long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Texas Instruments scores well for Dividend Safety with a rating of 75, suggesting that its dividend payment is very safe.
The company’s solid Dividend Safety Score is helped by its earnings and free cash flow payout ratios, which sit at 52% and 40%, respectively, over the last 12 months. While Texas Instruments does have some cyclicality to it, these are very reasonably dividend payout ratios to protect the dividend during an unexpected downturn.
As seen below, Texas Instruments’ payout ratios have significantly increased over the last decade but have remained relatively stable the last few years at a healthy level.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
Another factor we analyze to gauge the safety of a dividend payment is how a company performed during the last recession. Texas Instruments’ sales declined in fiscal years 2007, 2008, and 2009. When the economy weakens, less electronic equipment is manufactured and sold, reducing demand for the company’s chips.
Texas Instruments’ earnings per share also fell by more than 20% in each of those years, reflecting the high proportion of fixed costs in its manufacturing-intensive business model. The company’s stock ultimately declined by more than 50% in 2008, trailing the S&P 500’s return of -37%.
Texas Instruments isn’t a recession-resistant stock, so it’s especially important that the company maintains reasonable payout ratios and modest financial leverage.
Despite Texas Instruments’ sensitivity to the economy the company has a great business model that throws off free cash flow. By focusing on areas of the analog and embedded markets that are slower-moving and less technologically rigorous, Texas Instruments doesn’t need to invest as much in its manufacturing plants as other companies.
As a result of its strategic focus and scale, the company has generated positive and growing free cash flow for more than a decade. Perhaps most importantly, the company’s free cash flow margin is approaching 30%, which is remarkable for any type of business much less a chip manufacturer.
Companies that generate predictable cash flow every year are much better positioned to sustainably pay and grow dividends, and Texas Instruments fits the bill.
Source: Simply Safe Dividends
Return on invested capital is one of the most important financial ratios for dividend investing because it provides clues about a company’s business quality. Simply put, firms that earn high and stable returns on invested capital are more likely to have an economic moat and be better positioned to continue paying and growing their dividends.
As seen below, Texas Instruments has earned strong returns over most of the past decade, reflecting its strong market share positions, economies of scale, and strategic focus on high-return areas of the analog and embedded markets.
Source: Simply Safe Dividends
Turning to the balance sheet, we can see that Texas Instruments is in good financial health. The company maintains $2.8 billion of cash on hand compared to $4.1 billion of debt and enjoys investment grade credit ratings. Financial leverage does not appear to be a risk to the dividend, especially considering the company’s strong business fundamentals reviewed above.
Source: Simply Safe Dividends
Overall, Texas Instruments has an extremely safe dividend payment. The company is a free cash flow machine that maintains healthy payout ratios and a conservative balance sheet.
While demand for semiconductor chips could unexpectedly fall at any time, Texas Instruments looks well prepared to weather just about any storm.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Texas Instruments’ Dividend Growth Score of 81 suggests that the company’s dividend growth potential is very strong.
The company has paid uninterrupted dividends since 1962 and raised its dividend for 12 consecutive years, making it part of the Dividend Achievers Index.
Management last raised the dividend by 12% in 2015, and we can see below that Texas Instruments’ dividend has compounded by more than 20% per year over the last five years.
Source: Simply Safe Dividends
Dividend growth has been excellent over the last decade because of the company’s strategic shift to focus more on analog and embedded processing products. These businesses require less capital spending, freeing up an increasing amount of cash flow that was used to reward shareholders with dividend increases and share repurchases.
Going forward, dividend growth will likely be maintained at high single-digit pace. The way management determines dividend increases is by taking half of the company’s previous four years’ of free cash flow and using that as the target for the dividend hike.
Valuation
Texas Instruments’ free cash flow per share has compounded by 10% per year over the last five years, but I would expect a somewhat slower pace of growth going forward given the mature nature of the industry (the company’s revenue has essentially treaded water the last five years).
Assuming the company’s free cash flow compounds closer to a mid- to upper-single digit rate, Texas Instruments’ stock appears to offer annual total return potential of approximately 8-10% (2.5% dividend yield plus 6-8% annual free cash flow per share growth).
Texas Instruments trades at a forward price-to-earnings multiple of 20.9 and has a dividend yield of 2.5%, which is slightly higher than its five-year average dividend yield of 2.3%.
The stock appears to be somewhat reasonably priced but not a bargain today. I would be more interested on a 10-15% pullback.
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Conclusion
Texas Instruments is one of the highest quality semiconductor stocks that money can buy and is poised to continue paying higher dividends.
While I generally prefer to avoid investing in most of the technology sector, I can see why Texas Instruments could make a lot of sense to hold in a dividend growth portfolio.
The company dominates its slower-changing markets, maintains significant manufacturing advantages, focuses on generating consistent free cash flow, and presumably has plenty of room to continue moderately growing in its large, fragmented markets.
With more than 50 years of uninterrupted dividends and a fundamentally sound business model, Texas Instruments seems poised to continue rewarding shareholders for many years to come.
Texas Instruments certainly looks like a blue chip dividend stock, and I’ll continue watching it for a pullback on unexpected weakness in demand for chips.
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