- Performance of the analog segment in Q1 fiscal 2016 was disappointing.
- In the long-run, TXN has the potential to strengthen its top-line.
- TXN’s capital-light business model allows it to generate loads of free cash.
- None of TXN’s direct competitors can match the company’s cash-generating potential.
Texas Instruments (NASDAQ:TXN) sells semiconductors to electronics designers worldwide. In the last decade, TXN has become a highly capital-light business owing to the ever-increasing focus on analog and embedding processing technologies. This is one of the biggest reasons why the company stands out in the semiconductor industry. Analog and processing technologies are omnipresent as they are an integral part of virtually every electronics device. Little wonder then, that the market for these technologies is huge. The size of the analog market alone is$45 billion and TXN, with a roughly 15% share, shines as the biggest player in this space.
With a justifiable and pragmatic strategic focus, TXN certainly has the potential to achieve sustainable growth. In addition to this, the company's cash-generating potential and an unwavering commitment to returning value to its shareholders also add to its risk-reward profile.
The first quarter of fiscal 2016 wasn't TXN's best by any means as total revenue fell by 5% compared to the same quarter a year ago. This didn't come as a major surprise given the lackluster demand for personal electronics, especially mobile phones. The decrease in overall revenue was primarily driven by an ominous 8% decline in analog revenue, which completely masked the same percentage growth in embedded processing revenue. The thing is that TXN has a broad portfolio of analog semiconductors and it invests no less than $1 billion every year to expand its portfolio, so the woeful performance of the analog segment comes off as particularly disappointing.
The fall in analog revenue has altered TXN's revenue and operating profit composition. Much to the management's dismay, analog's contribution to the company's total revenue and operating profit has fallen by roughly 2% and 5%, respectively.
(Source: Company's latest 10-Q filing)
(Source: Company's latest 10-Q filing)
Boasting the highest operating margin of all segments, the analog segment is an extremely important source of profits for TXN. Plus, analog products have long life cycles, which means if TXN wishes to have a stable base of revenue, it absolutely needs to keep enlarging its analog market share.
On a positive note, in Q1 2016, TXN did see improvement in demand for industrial and communications equipment along with solid automotive demand. In coming years, I expect the semiconductor industry to become increasingly dependent on industrial and automotive markets, so this trend is likely to persist. TXN will benefit greatly as it derives about 46% of its revenue from these two markets. Whether the positive trends in industrial and automotive can make up for the weakness in personal electronics remains to be seen. It is also difficult to predict when we'll see a turnaround in personal electronics. TXN is expecting a sequential increase in demand but that won't be enough to lead to a year-over-year improvement.
In the long term, TXN could still benefit from the expected growth of the global personal electronics market. By 2020, smartphones are forecasted to account for 60% of consolidated market revenue; hence,TXN has opportunities to strengthen its top-line.
(Source: Grand View Research)
What I really like about TXN is that its capital-light business model enables it to generate loads of free cash that can be used to return value to shareholders and fuel organic growth of the business. Currently, TXN's FCF stands at a staggering $3.65 billion, up 1% from last year. This basically means for every $100 of sales, TXN generates a whopping $28 free cash. Without a doubt this company is a 'cash cow' that can afford to return as much as $3.5 billion in the form of share repurchases and dividends to its shareholders annually. Remarkably, only 8% of S&P companies have a cash return to revenue ratio greater than TXN's.
I also like to look at Cash Return On Invested Capital (CROIC or CROCI), which further sheds light on the profitability and cash-generating capacity of a firm.
TXN, as the chart below shows, generates around $25 for every $100 of invested capital. None of its close competitors, including the likes of STMicroelectronics (NYSE:STM) and Qualcomm (NASDAQ:QCOM), convert as much invested capital into cash. Amazingly, TXN's CROIC has consistently exceeded 15% since 2011 and this, in my view, is a reflection of the company's economic moat.
TXN is an extremely shareholder-friendly company that is poised to keep growing profitably. In recent years, TXN has been haunted by weak demand for personal electronics but that alone shouldn't deter potential investors. In the long-run, TXN's strong balance sheet, investments in manufacturing technology, and broad and differentiated portfolio of analog and embedded products will help it extend its competitive advantage.
Sporting a forward P/E of 17x, TXN at the moment doesn't look terribly expensive and is definitely worth a shot given its high growth prospects.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.