Texas Instruments: A Strong Dividend Increase Is Imminent

| About: Texas Instruments (TXN)
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The company has established a surprisingly strong record of dividend growth over the last decade that exceeds the record of many well-known dividend growth companies.

The company’s strong recent record of dividend growth results from its strategy to return to shareholders all free cash flow not needed for debt repayment.

The company is about to raise its dividend once again by about 8 to 10 percent in the next several weeks.

The company supports its dividend growth record though its investing in research in multiple high-margin, high-growth areas of the analog and embedded processing markets.

A purchase of the company’s shares at a value-oriented price will reward shareholders over the long term with dividend increases, share buybacks and share price appreciation.

Texas Instruments (NYSE:TXN), one of the largest semiconductor companies in the world based on revenues, has been one of our most pleasantly surprising investments in our portfolio. When we purchased shares in the company during the dark days of the post-2000 stock market crash, we never anticipated that the company would reward us and other shareholders with an aggressive plan to reward shareholders with substantial share buybacks and dividend increases. Since TXN instituted its plan to reward shareholders, it has rewarded shareholders with total dividend increases over the past decade or so of about several hundred percent. The company's dividend growth has vastly exceeded much of the dividend growth of many of the more typical dividend well-publicized growth stocks that investors typically consider for their portfolio. With that said, TXN is about to raise its dividend once again over the next several weeks.

TXN's latest earnings report revealed that the company's revenue and earnings exceeded expectations. The company also raised its estimates for the following quarter as well. When commenting on its results, TXN noted "continued strength in automotive, as well as improvement in industrial and communications equipment" and that the company's decrease in revenue was due to expected "weakness within the personal electronics market," specifically mobile phones. The company's strong results were indicative of its successful strategy of redirecting its business towards analog and embedded processing applications, which generally are a more stable business with stronger margins. Recent results clearly indicate then that a recovering auto and industrial markets are driving improved results for the company. Weakness in the communications, personal electronics and other markets, however, are an offsetting force but the company is managing such weakness to minimize its adverse effects. TXN's performance also benefits from its use of its internal manufacturing capacity for the majority of its products, which allows it to make opportunistic purchases of assets from other companies.

TXN continues to prudently invest its funds into research and development in multiple high-margin, high-growth segments of the analog and embedded processing markets. As the company increases its exposure to the industrial and automotive markets, it is also decreasing its exposure to the volatile consumer/computing markets. In summary, as noted, TXN has successfully transformed into a primarily analog-based company that generates higher margins, cash flow and returns to shareholders. TXN continues to be well positioned for long-term given its strong balance sheet and its ability to quickly lower utilization rates to effectively manage inventories. The company is also well positioned as it will continue to benefit from its broader exposure to steadier end-markets such as industrial and automotive markets.

As discussed below, TXN has established an enviable record of dividend increases that exceed the dividend increase track records of most companies of its size in any industry. Given that TXN's shares are sitting at record highs, its dividend yield is at a recent historically low level of 2.3 percent. While TXN's dividend yield is not relatively high, the company's recent history of strong dividend increases will increase an investor's yield on cost the longer such investment is held. With another strong dividend increase likely to occur in the next several weeks, shareholders will continue to benefit from the company's continued strategy of rewarding shareholders with dividend increases and share buybacks. With all of this in mind, we should note that investors should wait for a strong overall market correction before establishing a full position as the company's shares sit at 52-week highs.

First quarter 2016 earnings

In late April 2016, TXN announced earnings of 65 cents, an increase from 61 cents in the year-ago quarter. The company also recorded revenue of $3.01 billion, a 4.5 percent decrease from the year-ago quarter. The pro forma net income was $668 million, an increase from $656 million in the year-ago quarter. The company's analog division revenues (62 percent of total revenue) decreased 7.7 percent from the year-ago quarter. The embedded processing division revenues (24 percent of total revenue) increased 8.5 percent. The other division revenues (14 percent of total revenue) were flat from the year-ago quarter. TXN's gross margins increased due to its improving product portfolio where about 87 percent of revenue comes from high-margin analog and embedded processing products and manufacturing efficiencies. The company exceeded its long-term gross margin target of 55 percent over the last two years.

TXN expects second quarter revenue of between $3.07 billion and $3.33 billion. The company expects earnings to range from 67 to 77 cents.

Another Solid Dividend Increase is Imminent

As noted above, TXN is ready to increase its dividend in the next several weeks. From 2006, to the present day, TXN has established an impressive dividend growth rate that appears to show no signs of stopping given the company's intention of returning to shareholders all free cash flow not needed for debt repayment (for either share buybacks or dividend increases). As TXN successfully transformed towards becoming an analog product company, it began its strong record of dividend increases. In a period of about a decade, TXN's dividend has increased by about several hundred percent. The company's shares currently pay $1.52 annually for a current yield of 2.3 percent. Based on 2017 earnings estimates, the company's annual dividend for 2017 is likely to range between $1.64 and $1.68 (indicating an upcoming 8 to 10 percent dividend increase), representing a dividend yield ranging from 2.50 percent to 2.60 percent. As noted, elsewhere in this article, with TXN shares trading near 52-week highs we believe that investors should purchase the company's shares during the next overall market sell off at a more value-oriented price and to capture a higher yield than is currently available. Once an investor purchases TXN shares they are likely to continue to be rewarded with annual dividend increases over the long term in addition to substantial share buybacks. We believe that investors should recognize TXN's history of strong dividend growth as a primary reason to purchase the company's shares and place such shares on their watch list for not only share price appreciation, but also dividend growth.

Our view

From a shareholder perspective, TXN's intent to reward shareholders by using its free cash flow to establish a strong record of share repurchases and dividend increases is strongly shareholder friendly. The company's recent dividend increase track record, in particular, shows stronger growth than many of the consumer product and pharmaceutical companies that are typically thought of as dividend growth stars. TXN is about to raise its dividend once again in the next several weeks. The company has been able to stick to its shareholder friendly practices by prudently investing its research and development budget in multiple high-margin, high-growth areas of the analog and embedded processing markets. Such investment allows the company to slowly increase its exposure to the industrial and automotive markets, while decreasing its exposure to the volatile consumer/computing markets. TXN, now as a primarily analog-based company, is able to generate higher margins, increased cash flow and solid returns to shareholders.

The analog market is attractive for TXN 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. Analog markets, therefore, achieve increased price stability than in many digital markets, where commodity-pricing pressures prevail. Further, analog products typically have longer product life cycles than digital products and are less affected by competition. Analog products also have lower capital requirements for production facilities.

TXN's current price to earnings ratio is about 22.85 and the shares yield 2.3 percent. The company's forward price to earnings ratio is 22.20 based on 2016 earnings estimates of $2.95 and 20.25 based on 2017 earnings estimates of $3.23. Earnings estimates for both years have been revised upwards slightly in recent months. With overall markets at record highs and TXN shares near 52-week highs, we believe that investors should wait for the company's shares to fall within a price range of $50.00 to $53.30 to establish a full position (a forward price to earnings ratio in the range of 15.5 to 16.5).

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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.