3 Reasons Texas Instruments Stock is Indispensable (NASDAQ: TXN)


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Texas Instruments Incorporated (NASDAQ:TXN) recently announced strong first quarter financial results, with revenue up 14% from the prior year quarter. They reported first-quarter revenue of $4.91 billion and net profit of $2.2 billion. billion.

Not only do these quarterly results make the company an attractive addition to your portfolio, but we also believe that TXN’s diverse products and end markets, dividend growth and consistent stock buyback programs make the company an excellent investment choice. Additionally, their high operating and net income margins relative to their peers make Texas Instruments even more attractive.

Let’s start by taking a closer look at TXN’s products and end markets.

1.) Diversified Products and End Markets

Some products

TXN primarily focuses on the industrial and automotive markets with its analog and embedded processing products. The company is already the market leader in the analog and embedded processing markets, but there is still potential for growth as analog processors are used in every electronic device, while embedded processors are used in most.

Analog

Analog represents TXN’s largest segment, contributing approximately 77% of revenue in 2021, totaling $14.05 billion.

pie chart showing revenue

Revenue by segment (Texas Instruments)

TXN’s analog business includes power products, which are designed to handle varying levels of voltage and current, and signal chain type products that are created to detect, condition and measure real-world signals. These analog products are essential in every electronic device, as they supply, for example, the power necessary for the operation of the devices.

In our view, Texas Instruments has significant growth potential in this segment, as the analog market size was estimated to be around $74 billion in 2021. As our world becomes increasingly digital, the need for more and more chips is inevitable. Although competition is fierce in the semiconductor industry, Texas Instruments is well positioned as a market leader to gain more market share.

Integrated processing

The embedded market is estimated to be significantly smaller than analog, approximately $22 billion in 2021. TXN generated only 17% of its revenue in 2021 from this segment, totaling 3, 05 billion dollars.

The company is also the market leader in this segment.

Other

This segment contains well-known DLP products and calculators. Although most people associate Texas Instruments with calculators, it only represents a small percentage of total income. Moreover, the firm does not expect any growth potential in this area.

End markets

Texas Instruments sells its products in six end markets: industrial, automotive, personal electronics, communications equipment, enterprise systems and others.

pie chart showing revenue

Revenue by end market (Texas Instruments)

The company stressed that its objective is to place strategic emphasis on the industrial and automotive markets.

In our view, TXN’s focus on these two segments is an attractive approach. As more companies in the industrial and automotive markets attempt to create smarter and safer products, the demand for chips in these segments is poised to grow. We believe that with this strategy, TXN will be well positioned to meet demand. Additionally, TXN has already demonstrated the success of its focus on these two end markets, increasing their revenue contribution from 42% in 2013 to 62% in 2021.

In summary, we believe that TXN’s broad product lineup, within both major segments, and its diverse end markets provide security in times of volatility. If there is a drop in demand in one of their end markets, they have others to fall back on for a stable and continuous cash flow.

2.) Dividends and share buybacks

Over the past decade, Texas Instruments has allocated its capital in a consistent and disciplined manner.

bar chart showing capital allocation

Capital allocation (Texas Instruments)

Most of the capital was allocated to research and development, sales and marketing, CAPEX and inventory, in order to increase organic growth.

During the same period, TXN has consistently rewarded its shareholder by regularly repurchasing its shares.

bar chart showing shares outstanding

Number of shares outstanding (seekingalpha.com)

Over the period from 2012 to 2021, they have reduced their number of outstanding shares by almost 20%.

Over the past decade, TXN has also been committed to returning value to shareholders in the form of dividends. Not only has the company continued to pay dividends, but it has also continuously increased its payouts, reaching a quarterly dividend of $1.15 this year. This is almost a tenfold increase in the time period presented.

bar chart showing the dividend

Dividend history (seekingalpha.com)

Texas Instruments’ payout ratio, however, appears somewhat high, but is in line with its own historical average.

We believe that, both in terms of share buybacks and dividend payouts, TXN has rewarded its shareholders well. In our view, based on TXN’s strong cash flow generation and market leadership, the company will have no difficulty in pursuing both its buyback programs and its dividend payments. Therefore, for investors looking for stable cash flow, TXN could be an attractive choice.

3.) Improving margins

Over the past ten years, Texas Instruments’ margins, including gross margin, operating margin, and net margin, have experienced strong expansion.

line charts showing margins

Margins (macrotendances.net)

To put these margins in perspective: the median gross margin for the industry is around 50%, which is about 30% lower than TXN’s trailing twelve-month gross margins. The difference is even greater in terms of net profit margin. The industry’s median net profit margin is 5.6%, about 90% lower than TXN’s 43%.

We believe the gross margin expansion is attributable to TXN being a market leader in analog and embedded processors and having a competitive advantage. This position allows the company to have stronger pricing power, which could be a significant advantage in times of rising input costs. In our view, TXN’s margin expansion is very attractive in such a competitive market environment.

The operating margin improved faster than the gross margin, indicating that TXN is successful in controlling operating costs and increasing efficiency. Finally, the widening net profit margin proves that TXN’s business has significantly and consistently improved its profitability over the years.

Evaluation

Over the past four quarters, TXN has earned earnings per share of $8.48. For 2022, analysts expect earnings to be between $8.52 and $9.51 per share. This increase represents a 0.5% increase on the low side and an increase of approximately 12% on the high side.

These growth numbers combined with TXN’s low P/E and P/CF relative to its 5-year averages, their stock buyback programs, their dividend yield above 2% and their high margins make stock an attractive choice in our opinion.

Using the 5-year average P/E ratio, we estimate the fair value of TXN stock to be between $196 and $220, which represents an upside of 15% to 30%. Although the stock trades at a premium to its peers, we believe the higher price multiples are warranted.

Risks

Before concluding the article, we must consider some of the risks, which can have significant impacts on TXN’s operations and finances. In this section, we highlight some of the main risks presented by the company in its annual report.

1. Application for Semiconductors

In our view, near-term semiconductor demand could be volatile. Demand can be significantly impacted by manufacturers’ challenges in the industrial and automotive sectors, including labor shortages and supply chain constraints. However, in the long term, as our world becomes increasingly digital, we see a growing need for semiconductors.

2. Competition

Competition in the semiconductor industry is fierce. Constant innovation is required to keep up with changing market needs, which can be capital intensive. In addition, China’s restructuring of its domestic semiconductor industry could have significant long-term impacts for TXN.

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 compete. TXN’s large cash balance is also a plus.

3. Exposure to China

In our opinion, its exposure to China (customers based in China represent approximately 25% of revenue) could impact TXN’s business in the short term due to the Covid-19 restrictions in this country. In the long term, we expect these restrictions to ease and not have a material impact on business.

Key points to remember

Diversified products and end markets, with high margins, make TXN’s business an attractive choice.

Share buybacks and dividends have created significant value for TXN investors over the past decade.

The stock is undervalued based on price multiples with 15-30% upside potential.

Keep competition and exposure to China in mind before starting a position.

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