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Summary

  • The company is successfully transforming to a primarily analog-based company that will generate higher margins, cash flow and returns to shareholders.
  • The company intends to return to shareholders all free cash flow not needed for debt repayment.
  • The company has a recent history of substantial dividend increases and share repurchases.

Texas Instruments (NASDAQ:TXN) is a company that is successfully transforming to a primarily analog-based company that will generate higher margins, cash flow and returns to shareholders. The company is investing its research and development budget in multiple high-margin, high-growth areas of the analog and embedded processing markets. This strategy allows the company to gradually increase its exposure to the industrial and automotive markets, while reducing its exposure to the volatile consumer and computing markets. The company's shares currently yield about 2.5 percent and have a recent history of substantial dividend increases. While no stock should be considered a "safe stock" without any risk, TXN shares are relatively safe in comparison to many high profile momentum driven technology stocks and should be strongly considered as a building block of any long-term investors' portfolio where an investor wants exposure to the technology market with a healthy dividend yield.

Background

TXN is one of the largest semiconductor companies in the world based on revenues. The company's semiconductors are used for various tasks including: 1) converting and amplifying signals; 2) interfacing with other devices; 3) managing and distributing power; 4) processing data; 5) canceling noise; 6) and improving signal resolution. TXN's product portfolio includes products that are central to almost all electronics equipment. The company sells custom and standard products. TXN designs and sells custom products for specific applications for specific customers. TXN designs standard products for use by many customers and/or many applications that are typically sold through both distribution and direct channels. Standard products include both proprietary and commodity products.

TXN's product divisions are as follows: 1) analog semiconductors that change real-world signals such as sound, temperature, pressure or images by conditioning them, amplifying them, and often converting them to a stream of digital data so other semiconductors can process the signals; 2) embedded processing products that are the "brains" of many electronic devices (embedded processors are designed to handle specific tasks and can be optimized for various combinations of performance, power and cost, depending on the application. Embedded Processing products are used in many markets, particularly industrial and automotive); 3) miscellaneous products including smaller semiconductor product lines and handheld graphing and scientific calculators, Digital Light Processing (DLP) products primarily used in projectors to create high-definition images, and royalties received for patented technology that TXN licenses to other electronics companies.

Second-quarter earnings

TXN reported second-quarter earnings that increased 52.6 percent from the prior year's quarter. TXN's strongest market was the communications equipment market. The industrial and automotive markets were almost as strong. The personal electronics market was, however, impacted by softness in phones and tablets. TXN's revenue was $3.29 billion, an increase of 8 percent from the prior year's quarter (Excluding TXN's legacy wireless business, which contributed just $5 million in the second quarter but $148 million in the year-ago quarter, revenue was up 13.4 percent). The analog, embedded processing and other divisions generated 61 percent, 21 percent and 18 percent of quarterly revenue, respectively. The analog division grew 14.3 percent from the prior year's quarter. The embedded processing division, which includes the processor, microcontroller and connectivity product lines, grew 13.8 percent from the prior year's quarter. The other division, which includes DLPs, custom ASICs, calculators, royalties and some legacy wireless products decreased 13.2 percent from the prior year's quarter (The decline from the year-ago quarter was on account of legacy wireless products).

On a GAAP basis, the company recorded a net profit of $683 million, or 62 cents a share, compared to a net profit of $660 million (46 cents per share) in the comparable prior-year quarter. TXN spent $743 million on share repurchases and $323 million on cash dividends. Spending on share repurchases and dividends increased 13 percent and 32 percent, respectively. At the quarter-end, TXN had $4.39 billion in long-term debt and $254 million in short-term debt. During the quarter, the net debt position increased $224 million. With respect to TXN's share repurchase and dividend policy, the CEO of TXN stated: "Our strategy to return to shareholders all free cash flow not needed for debt repayment, and to return proceeds from exercises of equity compensation, reflects our confidence in the long-term sustainability of our business model." The CFO summarized the quarter stating:

"The second quarter demonstrates the strength of TXN's business model, focused on analog and embedded processing which we believe are the best opportunities inside of the semiconductor market. We continue to invest in areas that offer sustainable growth, solid profitability and good cash flow from operations. The percentage of our business from industrial and automotive markets continues to grow as customers increasingly embrace technology that makes end-products smarter and more connected. At the same time, we continue to invest in our manufacturing capabilities, and our strategy to opportunistically acquire manufacturing assets means that we can deliver strong free cash flows."

TXN's guidance for the third quarter is revenue between $3.31 billion and $3.59 billion. Excluding the legacy wireless business in the year-ago quarter, revenue for the quarter would be up 8 percent year over year. The earnings per share for the quarter is expected range from 66 to 76 cents per share.

Competitors and the analog market

The semiconductor market includes companies that manufacture and sell integrated circuits and discrete semiconductor devices. Major competitors in the market include Intel (NASDAQ:INTC), Texas Instruments, Micron Technology (NASDAQ:MU) and Advanced Micro Devices (NYSE:AMD). The industry is cyclical and subject to supply and demand fluctuations and price erosion. After a downturn during the most recent recession, the semiconductor market is recovering on renewed demand. Demand for semiconductor products is driven by sales of personal computers, cell phones, consumer electronics devices, and other electronic equipment. The industry is capital-intensive and requires significant investments to advance technology and reduce manufacturing costs. Research and development expenses are a major part of capital expenditures.

The analog market is attractive due to its relatively steady and profitable business model. Analog companies have thousands of products and a very broad customer base, which leads to a stable revenue stream. Analog markets are also attractive because they are not commodity products. The market is segmented, as there are many designs available and many analog suppliers compete for the analog positions on proposed circuit boards. When a company wins a place in a customer's product, however, the product price remains fixed for the run of the product. As such, analog markets achieve greater price stability than in many digital markets, where commodity-pricing pressures prevail. Analog products usually incorporate proprietary design elements. In addition, analog products usually have longer product life cycles than digital products and are less affected by competition from Asian competitors. Analog products also have lower capital requirements for production facilities.

Analysts' views and our views

Analysts believe that TXN is sensibly investing its research and development budget in multiple high-margin, high-growth areas of the analog and embedded processing markets. This decision by TXN allows the company to slowly increase its exposure to the industrial and automotive markets, while reducing exposure to the volatile consumer/computing markets. Analysts approve of TXN's transformation to a primarily analog-based company that will generate higher margins, cash flow and returns to shareholders. TXN also instituted a strategy where it seeks to generate a percentage of free cash flow in the range of 20 percent to 30 percent of revenue. The company intends to use such cash flow for share repurchases and higher dividends. Analysts see TXN's overall business strategy as attractive. That said, analysts believe generally that TXN's share price currently reflects the advantages of the company's business model. The majority of analysts have recommendations for TXN that are a "hold" with a few "buys" and target price ranges from $45 to $60 a share.

We generally agree with analysts' conclusions regarding TXN's shares. The current price to earnings ratio for TXN shares is about 23.6 and the shares yield 2.5 percent. In addition, the company has a recent history of substantially raising dividends in addition to the company's substantial share buyback activity. TXN's forward price to earnings ratio is 17.45 based on 2015 earnings estimates of $2.75. We should note that TXN has seen recent upward earnings estimate revisions suggesting that analysts are more confident in the company's short- and long-term prospects. That said, with overall markets at or near record highs an investor should wait for TXN's share price to pull back to between $41.25 to $44.00 to establish a full position (a forward price to earnings ratio in the range of 15 to 16). Finally, we should note that TXN's shares have seen extensive insider selling with no purchases in recent years.

Source: Texas Instruments: A Successful Transformation Play And Increasing Dividends