Texas Instruments Incorporated (NASDAQ:TXN) has recently announced strong first quarter financial results, with revenue 14% higher compared to the year ago quarter. They reported a first quarter revenue of $4.91 billion and a net income of $2.2 billion.
Not only do these quarterly results make the firm an attractive addition to your portfolio, but we also believe that TXN's diversified products and end markets, growing dividends, and consistent share buyback programs make the firm a great investment choice. Further, their high operating and net income margins compared to their peers make Texas Instruments even more appealing.
Let's start by taking a closer look at the TXN's products and end markets.
TXN is focusing on participating primarily in the industrial and automotive markets with their analog and embedded processing products. The firm is already the market leader in both the analog and embedded processing markets, but there is still potential to grow, as analog processors are used in each electronic device, while embedded ones in most.
Analog represents TXN's largest segment, contributing about 77% to the revenue in 2021, totaling in $14.05 billion.
To TXN's analog business belong power products, which are designed to manage different voltage and current levels, and signal chain-type products that are created to sense, condition, and measure real-world signals. These analog products are essential in every electronic device, as they, for example, provide the power for the devices to run.
In our view, Texas Instruments has significant growth potential in this segment, as the size of the analog market was estimated to be approximately $74 billion in 2021. With our world becoming more and more digital, the need for more and more chips is inevitable. Although the competition is fierce in the semiconductor industry, Texas Instruments is well-positioned as a market leader to gain further market share.
The embedded market is estimated to be significantly smaller than the analog, approximately $22 billion in 2021. TXN has generated only 17% of its revenue in 2021 from this segment, totaling in $3.05 billion.
The firm is also the market leader in this segment.
This segment contains DLP products and the well-known calculators. Although most people associate Texas Instruments with calculators, it accounts for a small percentage of the total revenue. Also, the firm expects no growth potential in this area.
Texas Instruments sells their products to six end markets: industrial, automotive, personal electronics, communications equipment, enterprise systems, and other.
The firm has highlighted that their aim is to put strategic emphasis on the industrial and automotive markets.
In our opinion, TXN's focus on these two segments is an appealing approach. As more and more firms in the industrial and automotive markets are trying to create smarter and safer products, the demand for chips in these segments are poised to grow. We believe that with this strategy TXN will be well-positioned to meet the demand. Further, TXN has already demonstrated the success of its focus on these two end markets, by growing their contribution to revenue from 42% in 2013 to 62% in 2021.
To sum up, we believe that TXN's wide range of products, within the two large segments and its diversified end markets provide safety in volatile times. In case demand in one of their end market decreases, they have other ones to rely on for continued, stable cash flow.
Texas Instruments in the last decade has been allocating its capital consistently in a disciplined manner.
Most of the capital has been allocated to research and development, sales and marketing, CAPEX and inventory, in order to increase organic growth.
Over the same time period, TXN has been consistently rewarding its shareholder, by consistently purchasing their shares back.
In the time period of 2012 to 2021, they have reduced their number of shares outstanding by almost 20%.
Over the last decade, TXN has also remained committed to return value to shareholders in the form of dividends. Not only has the firm kept paying dividends, but it also continuously increased their payouts, reaching a quarterly dividend of $1.15 this year. This is almost a ten-fold increase in the presented period.
Texas Instruments payout ratio however seems somewhat high, but is in line with its own historic average.
We believe that, both in terms of share buybacks and dividend payments, TXN has been nicely rewarding their shareholders. In our view, based on TXN’s strong cash flow generation and market leadership, the firm will have no difficulties in continuing both their repurchase programs and their dividend payments. Therefore, for investors who looking for stable cash flow, TXN could be an appealing choice.
In the last ten years, Texas Instruments' margins, including gross margin, operating margin, and net margin, have seen a large expansion.
To put these margins into perspective: the sector median gross margin is approximately 50%, about 30% lower than TXN's trailing twelve month gross margins. The difference is even larger in terms of net income margin. The sector median net income margin is 5.6% about 90% lower than TXN's 43%.
We believe gross margin expansion is attributable to the fact that TXN is a market leader in both analog and embedded processors and has a competitive advantage. This position allows the firm to have a stronger pricing power, which could be a significant advantage in times of rising input costs. In our view, the expansion of TXN's margins are very attractive in such a competitive market environment.
Operating margin has been improving faster than gross margin, indicating that TXN is successful in controlling its operating costs and increasing its efficiency. Finally, the widening net profit margin proves that TXN's business has been significantly and consistently improving its profitability over the years.
In the last four quarter, TXN had an earnings per share of $8.48. For 2022, analysts forecast the earnings to be in the range of $8.52 to $9.51 per share. This increase represents a 0.5% increase on the low side and approximately 12% increase on the high side.
These growth figures combined with TXN’s low P/E and low P/CF compared to its 5-year averages, their share buy back programs, their 2%+ dividend yield and their high margins make the stock an attractive choice in our opinion.
Using the stock 5-year average P/E ratio, we believe the fair value for TXN's stock is in the range $196 to $220, representing a 15% - 30% upside. Although the stock is trading at a premium compared to its peers, we believe the higher price multiples are justified.
Before concluding the article, we need to take a look at some of the risks, which may have significant impacts on TXN's operations and financials. In this section, we highlight some of the key risks presented by the firm in their annual report.
In our view, the demand for semiconductors in the short term may be volatile. The demand can be significantly impacted by the challenges of the manufacturers in the industrial and automotive industry, including labor shortages and supply chain constraints. However, in the long term, as our world is becoming more digital, we see a growing need for semiconductors.
Competition in the semiconductor industry is fierce. Constant innovation is needed to keep up with the evolving market needs, which may be capital intensive. Further, China’s restructuring of its domestic semiconductor industry may have material impacts for TXN in the long run.
We believe that TXN, as a market leader with high gross and net margins and with a disciplined approach to capital allocation, is well-positioned to handle the competition. TXN’s significant cash balance is also a plus.
In our opinion, its exposure to China (China-based customers represent about 25% of the revenue) could impact TXN’s business in the short term due to the Covid-19 related restrictions in that country. In the long term, we expect these restrictions to ease and have no material impact on the business.
Diversified products and end markets, with high margins, make TXN's business an attractive choice.
Both share buybacks and dividends have created significant value for TXN investors in the last decade.
The stock is undervalued based on price multiples with an upside potential of 15-30%.
Keep in mind the competition and the exposure to China before you start a position.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
Additional disclosure: Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article has been co-authored by Mark Lakos.