Seeking Alpha

Why I Recently Added Texas Instruments

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About: Texas Instruments Incorporated (TXN)
by: Brian Soule
Summary

After the latest earnings report and 4th quarter guidance, shares of TXN sold off double digits.

The semiconductor industry is cyclical and right now is on a downswing.

Texas Instruments is a blue-chip dividend growth stock that is a welcome sight in almost any portfolio, and it just went on sale.

This stock is on sale. Mind you, it's not a door-buster, clearance rack, "EVERYTHING MUST GO!" sale, but rather it has been modestly marked down to a level that I find attractive.

texas instruments preferred logo

Logo is a trademark of Texas Instruments

I have been following Texas Instruments Inc (TXN) for a long time, and nearly bought it last December around $90 (if only), but there were a lot of other wonderful choices available at that time. I bought Johnson & Johnson (JNJ) and Exxon Mobil Corp (XOM) instead, and I've been pretty happy with both of those decisions.

I didn't buy TXN then but continued to follow the stock and watched it climb to near $130 by late July. Then in early August it crashed down to the $117 level, but another stock I follow (and already owned), Genuine Parts Co (GPC), was also trading at too juicy a price to pass up. So instead of purchasing TXN for $117/share I purchased some GPC for $90.43/share, which worked out OK because those shares of GPC are up 13.4% since August.

However, after this latest earnings report I was once again offered the chance to buy TXN for $117 per share at the market open on October 23rd and this time I jumped on it.

While I've been following this stock for four to five years I've never actually owned it. So why was I so eager to scoop up shares at these levels? Well I'm glad you asked. Let's look at many of the metrics I usually examine before purchasing a stock.

To review, among the things I like to see are (in no particular order):

  • Growth in sales and profits
  • High cash flow
  • Lots of cash
  • Low debt or decreasing debt or both
  • The company rewards shareholders with dividends or share buybacks or both.
  • Nice yield on the stock
  • A growing dividend
  • And finally, we like to make sure the dividend can keep growing.

Growing Revenue Per Share

If you are looking for strong and steady growth in revenues, the semi-conductor industry is probably not where you want to look. It is widely known to be a cyclical industry and as such it experiences periods of very strong revenue growth dotted by periods of declining revenue, especially on a year-over-year basis.

However, TXN, at least on an annual basis, has managed to steadily grow their revenue per share despite this fact. The following figures were calculated based on data taken from Marketwatch.com.

2014 2015 2016 2017 2018 TTM
Revenue/Share 12.20 12.62 13.37 15.10 16.27 15.77

All charts and tables unless otherwise specified are created by the author

The last four quarters, including this past 3rd quarter, have all experienced negative YoY growth (each quarter has been lower than the same quarter from a year ago), and therefore the likelihood of 2019 continuing on this trend of revenue/share growth is basically zilch.

However, as Dave Pahl - Vice President, Head of Investor Relations, said on the latest earnings call:

...when you look at 30 years of history, semiconductor cycles can vary widely but typically experienced four to five quarters of year-on-year declines before returning to positive growth.

Now, to be fair, he also said:

...that the current trade tensions could impact the depth and duration of the cycle.

And the company guided the fourth quarter revenue to $3.07-3.33B, which would definitely be below last year's fourth quarter revenue of $3.72B, which would be a fifth quarter in a row.

Unless TXN is just being extremely conservative in their guidance, there is no reason to doubt that Q4 2019 will be the fifth quarter of YoY revenue declines. Eventually the cycle will turn and the revenues will start growing again. Based on history this will probably occur sometime in the next couple of quarters. As Samuel Clemens (Mark Twain) is believed to have said "History doesn't repeat itself but it often rhymes". So while the revenues might not start growing next quarter or the quarter after that, 30 years of history suggest they will start growing again fairly soon.

Take a look at the last ten years of quarterly revenues. You can see how bumpy the ride has been and that this quarter the YoY comparison was almost unfair. The highest spike on the graph below was the 3rd quarter of 2018. Next year's third quarter will have to compare to $3.771B instead of $4.261B, a much easier comparison.

Chart Data by YCharts

Free Cash Flow Generation

You should know by now if you've read any of my articles analyzing individual stocks that my absolute favorite thing to see in a stock is a company that generates bags and bags of cash for its shareholders. "Cash is king" is not a saying by accident, cash is absolutely essential for a successful and sustainable business, and the more a company generates the more excited I am to own a piece if it.

Image Credit

Texas Instruments is no slouch and definitely generates gobs of cash as the below table, courtesy of data from Seeking Alpha, demonstrates:

2014 2015 2016 2017 2018 TTM

Levered Free Cash Flow

3,722.60 3,368.10 3,577.00 3,999.50 4,519.40 4,514.40
Free Cash Flow / Share $3.45 $3.73 $4.07 $4.71 $6.25 $6.41

Now, the reason that the cash flow in 2018 and the cash flow for the trailing twelve months is relatively flat and yet the free cash flow per share continues to grow brings us to possibly my second favorite thing I like to see in a company. Namely, a company that shares the wealth with the owners of that company.

Show Me The Money!

I like seeing a company that returns some of the money that it earns to the shareholders. This can be through share buybacks or paying a healthy and growing dividend or both. TXN is one of those companies that returns cash to the owners using both methods. To quote Mr. Pahl once again:

As we note each quarter, we believe that free cash flow growth, especially on a per-share basis, is most important to maximizing shareholder value in the long term. We remain committed to returning all of our free cash flow to owners. Free cash flow for the trailing 12-months period was $6 billion, up 2% from a year ago.

Isn't that just delicious?

The reason the free cash flow/share continues to grow is because the number of shares that the company buys back with the profits is commendable. The share count has decreased from 1.07 billion shares at the end of 2014 to 970 million shares by the end of 2018, a 1.2% decrease per year on average. At the end of the third quarter of 2019 the share count had decreased to 935.2 million shares.

Not only are they doing this, but they pay a very acceptable and quickly growing dividend. I could provide a link to a website that lists the dividend growth rate and consecutive years growing the dividend for a bunch of stocks, or I could just quote the CFO, Mr. Rafael Lizardi:

In September, we announced we would increase our quarterly dividend by 17%, marking our 16th year of dividend increases.

Texas Instruments has raised their dividend by an average of 20%+ for the last ten years. Can this continue? I don't see how, I honestly don't. At some point the rate of dividend increase has to slow to approximately the rate of increase in free cash flow generation. But this past quarter the free cash flow generated was $1.97/share and the dividends paid were $0.90/share. The (just increased) dividend last quarter consumed less than 50% of free cash flow, and that is quite sustainable for the immediate future.

But is the yield very good? I like that the company is buying back shares and I like that they pay a growing dividend, but if it is a tiny dividend that doesn't help me much. I can spend dividends in my golden years on greens fees on a Tuesday morning. Or I could use them to buy the fetching Mrs. Soule and myself some boat drinks on the beach the following Thursday. But if the company takes all of their free cash flow and uses it to buy back shares, that doesn't help pay my bills. So I want to make sure the dividend I am getting paid as an owner of the company is going to keep me in good financial shape in my retirement. Well, at my entry price of $117/share, the yield on a $3.60 annual dividend is 3.1%.

Look at historical dividend yields for the last ten years and compare that to the 3.1% you'd be getting at $117 per share. How often does the yield get above 3.0%? Looks like, yeah, maybe a brief moment in late 2015 or early 2016. Getting in TXN for a yield over 3.0% is a rare chance indeed, and one that I am more than willing to take.

I should note that this chart below is the yield for the trailing twelve months, and the forward yield is a different calculation. The forward yield has gone over 3% more often, for example it was well over 3% in late 2018, but I am unable to find a chart that shows this.

Chart Data by YCharts

Quick Check of the Balance Sheet

As mentioned, I like to see a company that has low levels of debt or decreasing levels of debt or both. When a company has the levels of net debt that TXN has (virtually none, as you will soon see) I don't look very hard to see how fast the debt is being repaid.

As of September 30th, the company had $5.07 billion in cash and short term investments. Total debt came in at $5.8 billion, which means the company could essentially pay off (nearly) every nickel of long term debt with cash on hand if they wanted to. Obviously, this is not sound cash management because that cash is needed for more immediate needs and TXN and many other companies are able to borrow money at ridiculously low interest rates, but it is also obvious (I hope) that there is no danger of insolvency.

From the CFO, Mr. Lizardi:

Our balance sheet remains strong with $5.07 billion of cash and short term investments at the end of the third quarter. In the quarter, we repaid $750 million of debt and issued $750 million of debt with a coupon of 2.25% due in 10 years. This results in total debt of $5.8 billion with a weighted average coupon of 2.99%.

It might be nice to see a company with zero liabilities on their balance sheet, but that is just not reasonable for a company the size of TXN, and given that they just borrowed $750 million at 2.25% for ten years you can easily argue it probably isn't smart either. I am sure there are companies out there with zero debt on their balance sheet, and you can mention them in the comments section if it makes you feel better. Who knows, I might even take a deep dive into them and write an article about them. However, I am content to own a company with $0.7 billion in net long term debt that generates $4.5 billion of free cash flow per year.

How About the Valuation?

Ah ha, you say, Texas Instruments has a sky high valuation and I'm going to wait for a pullback before I pick up some shares.

Well, be my guest. I'm certainly not going to try to convince you to buy something that you feel is overvalued. I've felt (and feel) that Microsoft Corporation (MSFT) is overvalued and have been waiting for a pullback since about 2012 when it was trading for $25 per share. Hindsight being 20/20 and all, I probably should have scooped some up last December, but there was only so much cash and there were so many stocks I wanted at the time. In fact, if MSFT had an earnings report like TXN just did and had the kind of pull back we're seeing in TXN shares, this article would have a different title (and content).

But back to TXN, let me tell you what I'm seeing right now.

The current P/E ratio of the S&P 500 as I type this is reported as 23.68 according to the Wall Street Journal. The P/E ratio for the TTM for the Semiconductor industry is 23.7 according to Morningstar (subscription required). The current forward P/E of Texas Instruments according to Seeking Alpha is 22.86 and the TTM P/E is 22.0 according to Morningstar. So both looking forward and looking back, the P/E ratio of TXN is lower than the current P/E ratio of the S&P 500 and the industry they are a part of. By definition it is not overvalued, unless you consider the entire market to be overvalued.

Is the S&P 500 overvalued? I don't know. Could be. We just today (Monday, October 28th) closed at a new all-time high so you could make that argument. But I already have loads and loads of cash on my personal balance sheet and I want my retirement assets put to work in stocks that will pay me to own them now and will pay me more to own them in the future. I plan to have my retirement assets in the market for 10+ years, so I don't want to sit on a mountain of cash in my IRA now.

Possible Problems

The obvious near term issue is the 4th quarter guidance that TXN provided, guiding revenue down 14% YoY at the midpoint of the guidance. You never want to see that kind of guidance, but as I said it is a near term issue. Will the revenues be higher in five years or ten years? Not a guarantee, but almost a certainty.

One of the very attractive things about this stock is the incredible growth rate of the dividend. Seeking Alpha says the 5 year growth rate is 19.71%. I've already mentioned that I'm skeptical that the dividend can continue to grow at this rate. After all, 20% is an amazing rate of growth for pretty much anything in the financial world. If you earned 20% annually on your money, it would double in less than four years.

But with dividends in 2018 of $2.6 billion vs. free cash flow of $6.1 billion (42.2% payout ratio) is an 8% increase possible going forward? How about 10%? I mean, that would be alright with me. When is the last time you got a double digit raise at work? When is the last time you got it two years in a row, or three or five? I'd take that, especially with a starting yield of 3.1%.

Hormel Foods Corporation (HRL) has been increasing their dividend by double digits every year going back to 2010, so it is certainly possible to maintain that kind of growth. There are several other companies that have demonstrated the ability to hike their dividends by double digits year after year but very few of them are currently yielding 3% or more at present.

Conclusion

The recent pullback in TXN shares presented us with a great opportunity to pick up shares with a yield above 3%. Despite the cyclical nature of the semiconductor business, the superior management of Texas Instruments has managed to grow their revenue per share for several years in a row.

Texas Instruments believes very strongly in rewarding their shareholders both by repurchasing their shares and by paying a generous dividend that they have been growing at a fantastic rate.

The company generates an absolute ton of cash and they have a very stout balance sheet, with very little debt and almost as much cash as long term debt.

As mentioned I purchased shares pretty much right at the market open on October 23 for $117 per share, a 3.1% yield. As I type this the yield is down to 3.0%, but that is still quite attractive.

I hope you have enjoyed reading this, and if this stock makes sense in your portfolio I certainly hope you consider it. Like MSFT, this seems to be one of those stocks that is always "overvalued", but I believe that this recent pull back is a great chance to get into one of the better dividend growth stocks out there. Thanks for reading, and best of luck!

Disclosure: I am/we are long GPC, HRL, JNJ, TXN, XOM. 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.