With the economy moving towards that full employment inflection point, corresponding increases in consumer expenditures will deliver strong returns for growth stocks. Technology, in particular, faces impressive secular trends. Perhaps the best way to gain exposure across the sector is to invest in semiconductors, which directly feed most tech end markets. In this article, I will run you through a DCF model on Texas Instruments (TXN) and triangulate the result with a review of the fundamentals against four peers: Advanced Micro Devices (AMD), Applied Materials (AMAT), and Intel (INTC).
First, let's begin with an assumption about the top-line. TI finished FY2011 with $13.7B in revenue, which represented a slight decline off of the preceding year. I model growth trending around 7.5% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 50% of revenue versus 11.5% for SG&A, 12.5% for R&D, and 7% for capex. Taxes are estimated at 28% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around $150M over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8% yields a fair value figure of $35.42 for 11% upside. The company currently trades at nearly 15x FY2011 free cash flow, which means that it is more or less expensive.
Texas Instruments produced decent first quarter results:
The first quarter's results landed close to our expectations and were consistent with our belief that our business cycle bottomed in the first quarter. Analog revenue was about even. We were especially encouraged by the progress we continue to make with the former National Semiconductor product line, now called Silicon Valley Analog, as it gains traction with customers and holds a strong position in the important industrial market. Early signs point to the industrial market strengthening in the near term as opposed to the delayed recovery that we saw in the last cycle.
From a multiples perspective, it becomes clear that other semiconductors are more undervalued right now. TI trades at a respective 20.6x and 13.4x past and forward earnings versus 12x and 10.6x for Intel, 10.3x and 10.6x for Applied Materials, and 8.3x forward earnings for AMD. While TI certainly has a strong brand name, so do these peers.
Consensus estimates for Intel's EPS forecast that it will grow by 4.2% to $2.49 in 2012 and then by 7.6% and 8.6% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $2.60, the stock would hit $33.80 for around 20% upside. Of all of the semiconductors highlighted in this report, Intel arguably has the lowest downside. This stems from its top brand name and 3% dividend yield.
In my DCF model on AMD, I make several assumptions: (1) 10.5% growth over the next half decade, (2) operating metrics consistent with 3-year historical average, (3) a 2.5% perpetual growth rate, and (4) a WACC of 9%. Free cash flow is estimated at around $300M in 2013. The company currently trades at around 17.2x that estimate, so it is slightly pricey. But, from a bottom-line perspective, the 8.3x forward earnings has set the bar low.
Consensus estimates for Applied Materials's EPS forecast that it will decline by 40.8% to $0.77 in 2012 and then grow by 45.5% and 13.4% in the following two years. According to NASDAQ, the stock is rated slightly more favorable than a "hold" right now. While the dividend yield of 2.7% is reasonable, earnings uncertainty will still allow for higher risk-adjusted returns.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.