Without Texas Instruments (TXN), most of the world’s electronic equipment would not function. The company is an extremely important player in virtually every end market and maintains numerous competitive advantages.
Texas Instruments has also been a free cash flow machine, converting close to 30 cents of every $1 in sales into free cash flow. Not surprisingly, the company scores strongly for Dividend Safety and Dividend Growth and has paid uninterrupted dividends for more than 50 consecutive years.
Let’s take a closer look at this technology giant for our Top 20 Dividend Stocks portfolio.
Texas Instruments was founded in 1930 and primarily focuses on manufacturing analog chips (64% of revenue) and embedded processors (21%).
Analog chips are used in nearly all electronic equipment to monitor, amplify, transform, or regulate signals found in the real world such as pressure, light, temperature, weight, and sound. Analog chips also provide voltage regulation and help manage power usage.
Embedded processors act as the “brains” of many electronic devices and are designed to handle a variety of specific tasks in items ranging from electronic toothbrushes to automotive infotainment systems. Its major product lines include microcontrollers, processors, and connectivity products.
Texas Instruments sells into most major end markets, including industrial (31% of sales), personal electronics (31%), automotive (15%), communications equipment (13%), and enterprise systems (6%).
The company sells more than 40,000 products and adds more than 500 new products to its portfolio each year. Texas Instruments sells its products to more than 100,000 customers, and Apple was its biggest customer last fiscal year accounting for 11% of total revenue.
Texas Instruments gains competitive advantages from its size and strategic focus on analog semiconductor chips.
In 2009, the company made a major decision to exit its wireless business, which represented 20% of Texas Instruments’ revenue in 2008 and primarily supplied chips used to connect cell phones to cellular networks.
Management feared the wireless business had already seen its best days and was headed on the path towards commoditization.
By exiting wireless, Texas Instruments could focus its investments on analog chips and embedded processors, which possess much faster growth potential. These two categories accounted for roughly 86% of the company’s sales last year, up from 44% of revenue in 2006.
Participating in the analog market has numerous appeals. Many analog chips go into products with long lifecycles, such as automobiles. As a result, they have a slower pace of technological change and don’t require substantial investments to maintain cutting-edge manufacturing processes and technologies. This allows analog chip companies to generate higher returns on invested capital, throw off more free cash flow, and enjoy greater stability (some products generate revenue for decades).
Since Texas Instruments is also well diversified by product and customer, it also has less risk of product obsolescence and rapid price erosion. No single customer, product, or market can take the company down.
Many analog products such as those used in industrial equipment and automotive markets are mission-critical and must last a long time. Designing these chips requires a good deal of creativity and specialized skills.
Texas Instruments has estimated that it takes at least five to 10 years of experience beyond graduate school to develop an analog engineer’s skill. When combined with Texas Instruments’ long-standing customer relationships, it’s no wonder why the company is so entrenched in its markets.
Texas Instruments also gains several advantages from its size. The company has the scale need to efficiently manufacture most of its products in-house and invested over $550 million on capital expenditures last year alone.
By owning its own factories, Texas Instruments has more control over its supply chain to support its customers and can manufacture its products more cost-effectively than its peers.
Texas Instruments build the industry’s first and only 300-millimeter wafer fab for analog manufacturing in 2010, reducing its wafer cost by 40% compared to the process used by most of its competitors. Building the 300-millimeter fab cost $8 billion and requires a massive base of customers to keep their capacity utilized, preventing smaller players from effectively competing on cost.
The company’s size also allowed it to invest approximately $1.3 billion in research and development last year. The company’s investment in innovation has helped it maintain a strong, broad-based portfolio of more than 42,000 patents.
Equally important, Texas Instruments maintains the broadest portfolio of analog chips and embedded processors in the industry. The breadth of the company’s portfolio helps it solve more needs than its competitors, giving it access to more customers and the ability to generate more sales per system.
Texas Instruments also has the industry’s largest global sales force and distribution channels, helping it provide reliable service to its customers and more effectively help them navigate the chip design process.
These factors have helped the company gain market share in analog and embedded processing for six consecutive years. Texas Instruments currently holds leading market share positions in four major categories of analog products. It is number one in amplifiers, interface, and power products and number two in data converters.
From a growth perspective, the analog and embedded processor markets are large and fragmented.
Texas Instruments believes the analog market is $45 billion in size. The company holds the number one position in the market with 18% share, providing room for continued consolidation.
The embedded processing market is roughly $18 billion in size, and Texas Instruments is again the largest player with 15% share.
Importantly, virtually every electronic device requires analog technology and most use embedded processing as well.
Some markets such as automotive are experiencing particularly strong growth as products become smarter and demand more semiconductor content. Texas Instruments is positioned to see its business continue to moderately expand as electronics become smarter and more connected.
Looking ahead, the company’s management team believes free cash flow margins can expand from about 27% to 30%.
As Texas Instruments builds more analog products at its 300-millimeter wafer fab, it will enjoy lower costs for more of its chips. Additionally, filling up excess capacity at its fabs will further increase free cash flow because incremental production carries very high margins given the amount of fixed costs in the business.
Overall, Texas Instruments appears to have a fundamentally solid business. It benefits from operating in slow-changing markets and uses its manufacturing, technology, and distribution advantages to protect its leading market share positions.
Get Dividend Stock Ideas and Research Tips Each Week
Texas Instruments’ Key Risks
Texas Instruments can be whipped around over short periods of time. Demand for some of the company’s products can rapidly increase or decrease without any notice, resulting in occasionally volatile quarterly results.
While the stock can be impacted by unexpected shifts in demand, this really isn’t a risk that threatens the company’s long-term earnings power.
More importantly, the semiconductor industry constantly faces technological change and intense pricing competition. It is also very mature, potentially making longer-term growth more difficult.
While Texas Instruments focuses on products and markets characterized by a much slower pace of change and longer product cycles, the very nature of technological innovation is unpredictable.
The company’s financial strength and diversification by customer, end market, and product help combat this risk, but it’s worth remaining aware of.
A final long-term risk to consider is Texas Instruments’ decision to do most of its manufacturing in-house. Rather than