It’s time to discuss Texas Instruments Corporation (Nasdaq: TXN), a company I have included in a number of model portfolios in the past two years. However, I have never covered stock in one stock article.
TXN is unique because For several reasons. The company is a great dividend growth stock that comes with a relatively high yield and high, steady dividend growth. Moreover, its broad moat business delivers high growth rates that make the strong earnings growth sustainable.
Moreover, Texas Instruments is dependent on economic developments. Right now, chip demand is slowing down a bit. While this is keeping a lid on TXN shares for now, it could provide attractive investment opportunities in the future.
So lets get it!
TXN – High Tech Earnings Growth
Technically, I own zero dividend growth stocks in the technology sector. while I would point out that the definition of technology is somewhat vague, there is a reason why most dividend investors have limited technology exposure. Technology is driven by companies that are ahead of the latest trends. It does not happen often that mature companies with decent returns and companies with high growth rates.
While companies like Apple (AAPL) and Microsoft (MSFT) are certainly outliers, they don’t come with high returns.
Looking at the overview below, we see that Texas Instruments has a truly unique dividend card.
- The company has a dividend yield of 3.0%, which is very impressive compared to the average yield of 1.5% in the tech sector.
- The company has a payout ratio of 52%.
- Over the past five years, its dividend has been raised, on average, by 15.6% annually.
- Since 2004, the company has raised its dividend every year, resulting in 19 consecutive years of dividend growth at an average compound growth rate of 25%!
- The most recent increase was announced in September when management rose 7.8%.
Thanks to these qualities, TXN has outperformed the S&P 500 without any major break since the Great Financial Crisis, as shown in the chart below. Between the early 2000s (the dotcom bubble) and the Great Recession, performance was in line with the market.
Moreover, it must be said that TXN is outperforming the market with weak volatility. The current 30-day volatility is 23%, which is just 300 basis points more than the Technology Select ETF (XLK) volatility. That’s impressive, because we’re comparing one stock to a basket of stocks.
These numbers confirm the theory that high-quality dividend growth stocks can outperform the market on a long-term basis with very favorable risk/return, as shown in the overview below.
In addition, the company has bought back 18% of its shares over the past 10 years. While there are companies that have more aggressive buybacks, this helps the company increase its earnings per share and share price.
At this point, it must also be said that TXN’s stock-based compensation is very small compared to buybacks. It happens so often that buybacks in the tech sector barely make up for the generous stock-based compensation that some companies feel SBC’s are an easy, cashless way to reward employees.
Both buybacks and dividends are part of the company’s long-term capital allocation plan. Between 2013 and 2022, the company spent slightly more on buybacks than earnings.
R&D spending outpaced both buybacks and dividends, which makes sense, because organic growth is the only thing more important than a shareholder dividend. After all, if TXN fails to innovate, its profits become unattractive.
So far, so good.
Now, let’s dive a little deeper into the numbers to assess why the company is able to deliver such high-quality earnings.
Factors that make TXN so special
Texas Instruments, with a market capitalization of $154 billion, is a semiconductor company that designs and manufactures electronic components that are sold to global electronics designers and manufacturers.
Founded in 1930, the company has a presence in more than 30 countries, and is headquartered in Dallas, Texas.
TXN operates through two main divisions: analog and inline processing.
According to the company, thanks to its long-standing commitment to making electronics affordable through semiconductors, TXN has pioneered the shift from vacuum tubes to transistors and integrated circuits.
The analog segment, which accounts for 77% of its sales, focuses on semiconductors that adapt and amplify real-world signals and manage power in electronic devices.
These products are essential to powering devices and facilitating interfaces with humans, the real world, and other electronic devices. Analog products find applications in the industrial, automotive and personal electronics markets.
The embedded processing section includes digital processors that act as the brains of various electronic equipment. These processors are designed for specific tasks, allowing performance, power and cost optimization based on application requirements.
These products are widely used in the industrial and automotive markets.
What’s interesting is that customers often invest in their own research and development to develop software that runs on TXN products, which leads to longer customer relationships. It also supports TXN spreads.
When both segments are combined, the company generates 40% of its revenue in the industrial industry, 25% in the automotive industry, and 20% in the personal electronics industry.
With that said, I’ve already mentioned briefly that this Texas-based company has the edge when it comes to efficient operations. She has great client relationships that allow her to leverage her capabilities.
Looking at the chart below, we see that since 2000, TXN has increased its revenue by 103%. However, free cash flow has grown nearly 360%, including the recent recession caused by higher capex. The company more than doubled its capital expenditures. But more on that later.
Essentially, the company has a strategy of maximizing free cash flow, which is built on three pillars.
- First, TXN focuses on analog and embedded processing products, leveraging four competitive advantages: strong manufacturing and technology foundation, product variety, wide market access, longevity and variety of products, markets and customer attitudes. This is basically maintaining a strong product portfolio.
- The second pillar is disciplined capital allocation, which includes careful selection of research and development projects, investments in new manufacturing capacity, development of online platforms such as its own website, acquisitions, and cash returns to shareholders through dividends and share buybacks. TXN has committed $87 billion over ten years, with a large portion of that invested in organic growth and capital expenditures expected to drive future free cash flow growth. This explains the aforementioned rise in CapEx, as the company prepares for the semiconductor future with huge investments in Texas and Utah.
- The third pillar is efficiency, as the company strives to maximize output for every dollar spent. This involves focusing on impact areas rather than simply optimizing cost reduction. Efficiency initiatives contribute to revenue growth, improved gross margins, controlled R&D and G&A expenses, free cash flow margins, and total free cash flow growth per share. By looking just at operating margins and EBITDA, it’s fair to say that the company has — so far — been successful in increasing its operational efficiency.
However, TXN is currently trading 14% below its all-time high. The stock is up 2.7% year-to-date. The S&P 500 rose 8.4%, driven by technology stocks (+28%).
Headwinds and Evaluation
Last month, Bloomberg reported that TXN provided disappointing sales forecasts, pointing to weak demand in the chip industry.
However, despite the lackluster outlook, the stock received a boost from broader optimism about a recovery in the technology sector. Bloomberg noted that investors and analysts remain confident that a recovery is imminent. Alphabet (GOOGL) and Microsoft’s positive quarterly reports also contributed to the positive sentiment, easing concerns that chip demand could fall off a cliff.
After all, TXN is to some extent a leader in global chip demand.
In the first quarter of ’23, revenue was $4.4 billion, which is down 11% from the previous year. Gross margin decreased by 480 basis points.
The company has seen weakness in a number of end markets, with the exception of automobiles, which are currently benefiting from easing supply chain bottlenecks.
Customers reduce orders to lower their inventory levels. So far, the company has been able to control its inventory by reducing sales through distributors while increasing its internal inventory.
While the company doesn’t comment on future demand, it is investing in in-house manufacturing capabilities and better customer relationships, which should pay off if supply chain re-support is accelerated.
These investments are expected to drive up capital expenditures from $2.8 billion in 2022 to $4.8 billion in 2025. The result is a temporary decline in free cash flow, followed by a gradual improvement, as free cash flow growth is expected to offset capital requirements the above.
This means that earnings growth is likely to slow, as the cash payout ratio is close to between 90% and 100% using estimates for 2023 and 2024.
Net debt is expected to increase from negative $2 billion in 2021 to $4.2 billion in 2025. While that may sound like a lot, it still can’t push the net leverage ratio above 0.4x EBITDA. This explains why TXN has an A+ credit rating.
Furthermore, using free cash flow as a valuation, we’re dealing with a somewhat unattractive valuation, as the company is trading at 31x 2024E free cash flow.
However, using this assessment would not be very fair. After all, free cash flow is only going down because of important investments in the company’s future. Using that as an argument that TXN stock is not attractive would be a mistake.
However, EBITDA is slowing due to weak economic growth. This year, EBITDA is expected to decline to $9.1 billion from $11.1 billion in 2022. Next year could see it rebound to $10.1 billion.
Hence, the EBITDA multiple remains slightly above the long-run average.
TXN shares are not overvalued. However, it is also not so attractive that I feel a sudden fear that something is missing.
Analyst estimates reflect this. The current agreed price target is $180, which is 5.8% higher than the current price.
If TXN shares fall into the $140-$150 range, I would be interested in adding the stock to my portfolio.
I think it’s a great stock for earnings growth in the technology sector with high, long-term sustainable earnings growth potential.
Texas Instruments is a unique stock of earnings growth in the technology sector, with a 3.0% yield, consistent dividend growth, and 19 consecutive years of growth.
It has the ability to outperform the market with subdued volatility. Despite the near-term headwinds in chip demand, TXN’s investments and efficient operations position it well for the future.
While the valuation is not exceptionally attractive, a potential buying opportunity could arise if the stock falls into the $140 to $150 range.
Overall, TXN offers a compelling option for investors seeking sustainable earnings growth in the technology sector.