It has been a while since I did a deep-dive analysis post on my blog, and I wanted to pick a business that is more closer to my area of expertise i.e. firmware, semiconductors, signal processing etc. Folks, let me introduce you to Texas Instruments (ticker: TXN).
Note: In the broader semiconductor industry, Texas Instruments is commonly referred to as “TI”. However, in the interest of being consistent with the associated stock ticker, I will refer to this company as “TXN”.
The first thing that comes to most people’s minds when they hear about TXN is…..calculators! Interestingly though, in my case atleast, that is NOT how I first heard about TXN. In fact, the calculator that I used during my engineering studies was a Casio, it served me well and did its job. But if you were to think that calculators is all there is to TXN, you would be dead wrong! Let us get into that a little later in the post. First, let us go into the history and background for this company.
History & Background
TXN’s history can be traced back to two physicists who developed a seismographic process to aid in oil exploration. This parent company was called Geophysical Services Incorporated (GSI) founded in 1930. During the early stages of World War II, GSI was exploring ways of using their oil exploration technology for submarine detection. This prompted a massive shift towards developing defense electronics. By around 1951, the defense electronics division of GSI was growing faster than the original geophysical division. A resulting re-org resulted in the birth of a new company called Texas Instruments, as we know it today.
TXN was at the forefront of the first ever integrated circuit or IC chip ever developed, which revolutionized the semiconductor industry. This eventually led to the development of the first hand-held calculator based a single-chip microprocessor. TXN is also credited with the development of a first known speech synthesizer chip which found its way into the Speak and Spell toy (picture above).
As one can see, this company has come a long way since its humble beginnings in the 1930s and is today one of the powerhouses of the semiconductor industry.
Like I said before, my first introduction to TXN was not through its famous calculators. Rather, I came across TXN while studying signal processing in my engineering studies and using one of the older versions of their Code Composer Studio IDE while working with one of their digital signal processing chipsets.
Since then, I have played around with several of their software driver components for firmware engineering development work/side projects ranging from PCIe root-complex/endpoint software pieces, A2D/D2A converters and also development boards such as the MSP Launchpad kit. As an engineer, it is easy to tell when components such as these (and the associated supporting documentation) have been designed with care and with quality in mind.
One of the first things that catches your attention when you open the investor relations page on ti.com is the following quote by their current CEO, Rich Templeton.
The best measure to judge a company’s performance over time is growth of free cash flow per share, and we believe that’s what drives long-term value for our owners.
To a serious long-term dividend growth investor such as myself, there is nothing more satisfying than reading this upfront. TXN reiterates this point in all of their presentations and company filings. To achieve this goal, the company adopts a three-pronged strategy:
- Strong business model: divided across two primary segments: analog and embedded processing built around four competitive advantages: manufacturing and technology, broad product portfolio, diverse and long-lived positions and efficient market channels.
- Disciplined allocation of capital
- Efficiency: striving to maximize output from every dollar that is spent.
The business segments can be further elaborated as follows:
- Analog: Further sub-divided into power and signal chain categories. The Power category includes products that will help customer manage power in their electronic devices. The portfolio includes battery-management systems, power switches, regulators. The Signal chain category includes products such as data converters, clocks, amplifiers etc. It is therefore, not at all surprising to see TXN’s battery charger and DC/DC converter components in teardowns of smartphones such as iPhone.
- Embedded Processing: In TXN’s own words, these are the digital “brains” behind the electronic equipment. Products in this portfolio can range from low-cost simple microcontrollers to complex motor controller systems.
Per the numbers in 2020, Analog is responsible for about 75% of sales, with Embedded Processing contributing about 18%. The remainder of the sales are classified in the “Other” segment which includes calculators and custom ASICs (application specific integrated circuits).
Also, per the latest available 10-K, here is a table denoting the markets for each of the products manufactured by TXN specified in decreasing order of revenue.
As one can see, Calculators (atleast as of 2020) accounts for no more than 2% of TI’s revenue. More importantly, you can see what the management really means by “broad product portfolio” as a competitive advantage when you see the above table. TXN has its tentacles spread in several sectors in the market! And none of these sectors are going to be irrelevant atleast in my lifetime.
I wanted to look at the revenue trends across the two main segments for the last 10 years.
So Analog segment’s revenue has been consistently growing, while the Embedded Processing was increasing during the first 5 year period but has since been decreasing. This does not concern me in any manner, and I think TXN should be investing in both these segments rather than becoming a one-trick pony and only focusing on analog semiconductors.
TXN is one of the popular names in the dividend growth investing community. Lets take a look at the dividend history to see why.
I borrowed the above graph from one of the recent company presentations. If you look at this graph, it is not at all surprising to see why this stock gets so much love in the dividend investing community 🙂
TXN, at the time of writing this, is yielding about 2.44% (annual dividend of $4.60). They have been increasing their quarterly dividend for nearly 16 years, with a 3-year, 5-year, 10-year dividend CAGR of 16.98%, 20.75% and 22.35% respectively. The last increase to the quarterly dividend was announced during Sep. 2021 and was about 13%.
Seriously, can anyone tell me what is not to like here?
The central question that a dividend investor is interested in is how safe is the dividend in the long run. To answer this, I look over the company’s financial statements to decipher the following:
- Is the company’s revenue growing?
- How profitable is the company?
- What are the company’s assets and how much does the company owe in the short-run and the long-run?
Analysis over the last 10 years show that total revenue has remained largely flattish. But what is interesting is that net income (and consequently net margin), during the same time period, has increased. The median net margin over the last 10 years has been around 22%. The last 5-yr average for net margin is about 31%.
I wanted to take a closer look at the free-cash-flow numbers. From the company’s slide-deck, I found this out:
This is exactly the kind of trendline that a long-term investor would like to see for Free-cash-flow growth, nice and consistent and TXN has been doing this for the last 16 years. In addition to the net-income growth, it appears that TXN has also been focusing on capital expenditures wherever feasible, thus sticking by one of the stated competitive advantages regarding efficiency.
TXN has a rock-solid balance sheet, with cash and cash equivalents effectively covering whatever the company owes as short term liabilities. And the long-term liability also does not look concerning whatsoever.
I also wanted to take a look at the total shares outstanding to see if the management has been focusing on share buybacks.
In this case, we want to see if the number of shares outstanding has been reducing and as we can see, during the 16 year period starting from 2004, management has been focused on share buybacks, thus using capital effectively and also providing value to the shareholders. Put this in perspective of the dividends paid and cash returned per share during the same time period has seen an annual growth of nearly 17%. Quite staggering!
My final comparison is w.r.t overall performance versus the S&P 500.
For this estimation, the comparison was performed against SPY which is an ETF that tracks the S&P 500 index and the chart computes how an amount of $10,000 would grow from 1995 to present day. TXN comfortably outperforms the S&P 500 during this period. FWIW, I performed the same test without dividends re-invested and the numbers were fairly similar.
TXN has stated that it is focusing on building a third wafer fab for its 300mm analog product line in Richardson, Texas. Generally, the construction of a fab is a capital intensive exercise, so I will be keeping a close eye to see how this impacts the free-cash-flow generation in the next few years. Given that the management sees this as a move to support demands for the next three years, I think this is a positive move. In addition to this, in October 2021, TXN completed its acquisition of Micron Technology’s 300mm semiconductor factory in Lehi, Utah. So I see TXN well positioned to meet demands for next few years.
I am fairly confident about the safety of the dividend in the coming 5-10 years atleast.
Risks & Market Characteristics
- Competitive Landscape: It may sound obvious, but it is worth re-stating that the semiconductor industry is fiercely competitive. TXN is no different, as it faces and will continue to face competition from semiconductor suppliers from different geographies (particularly Asia). For this reason, they need to consistently re-evaluate their landscape, spend on R&D and innovation and defend their market share aggressively.
- Semiconductor cycle: TXN outlines this in one of their investor slide decks, simply stated: this refers to the ebbs and flows of supply and demands in this industry resulting in building and depleting of inventories. We had one such ebb very recently when the semiconductor shortage due to surge in demand and the inability of the manufacturing capacity to keep up with this. TXN tries to safeguard against this by understanding the customer demands and managing inventories accordingly. However, it is worth noting that this can have an impact on the overall revenue numbers.
- TXN has stated that due to the nature of the market and associated seasonality, they typically expected the first and fourth quarters of the year to be weaker than the other two quarters.
- Hiring and retaining top talent: This may sound like a no-brainer, but this is especially critical for the analog semiconductor industry. Top talent and management are not easy to find and replace in this domain.
I used the Discounted Cash Flow valuation model to estimate the intrinsic value for this business. For my estimation, I used analyst estimates for revenue for the next two years of $17.93b and $18.72b respectively. Based on the last five years, I assumed a average net margin of roughly 30% and net income to free cash flow ratio of about 110% (again averaged for the last five years). These numbers are fairly conservative looking at the recent trends in both FCF and net income growth. I used these to estimate the future cash flows for the next five years and then discounted them to obtain the present value of the company. Also for my estimation, based on the Capital Asset Pricing Model, I am assuming a equity rate of 9.4%. Adding in a margin of safety of around 10%, I estimated the fair value of the stock to be around $142. TXN, at the time of writing this, is trading at $190. So I am not really a buyer at these prices.
My estimation does not look way off if you look at the non-GAAP FWD price to earnings ratio (currently around 23.62). EV/EBITDA (FWD) is also at 17.98, higher compared to the 5-year average of 16.55.
While this seems slightly overvalued at present, this is one of those stocks that I will double-down on when the stock dips appreciably. Until then, I will simply dollar-cost average into this position.
One of the things that the curious investor would immediately notice is that most of the management, CEO, COO, and most of the senior VPs have been with TXN for several years (20+). For instance, Rich Templeton, the CEO, joined TI straight out of college back in 1980. It is pretty awesome that the company has hired their CEO from within the organization.
I have listened to Rich Templeton talk in interviews and conference calls and kind of like the guy. It is helpful that he is an electrical engineer himself and therefore his answers are crisp, to the point, with no bull-shitting around. In a recent interview, when asked about a question on decision making, he said something very interesting:
“In our business, you will be rewarded for moving fast and correcting as you go. And if you find people avoiding mistakes, you will find people probably avoiding taking action…and that’s usually, especially in a technology business, very problematic.”
I find that comment very insightful, in the context of leading a business in a sector that changes as dynamically as the semiconductor industry. It is a valuable insight if you look at another big name in the semiconductor industry, Intel (ticker: INTC), who were sitting on their backside and executing poorly when AMD and NVIDIA were encroaching on their market share. A lot of this was, IMHO, due to poor management. Thankfully, INTC now has an engineer as its CEO and while these are still early days, the initial signs of a turn-around happening look promising.
Here is a snapshot for the reviews from Glassdoor with Rich Templeton getting a 95% approval rating. Overall reviews also look acceptable.
My analysis shows why I am very confident about TXN and its management. This company is going to be around for the next several years and if they stay true to their guiding principles of their business, they will return cash back to me, the shareholder. It should come as no surprise as to why I have TXN in the “Core” category of my dividend portfolio.
Do you have TXN in your portfolio? Does your analysis line up with what I have presented here? Please drop a comment to let me know what you think.
PS: You can connect me with on Twitter at @LifeWDividends. I am here to learn with you and from you.
Discl: Long TXN, INTC