For almost a decade now Texas Instruments (TXN) has focused on analog and embedded products for the industrial and automotive markets. That’s because TXN felt like focusing on the best products and the best markets for its semiconductors would enable it deliver excellent returns. Last year it delivered for shareholders: for full-year 2019 the company the company generated free-cash-ﬂow of $5.8 billion (40% of revenue), and returned $6.0 billion to shareholders in the form of dividends (the quarterly dividend increased 17% – the 16th straight year of dividend increases) and shareholder buybacks. In fact, due to the company’s commitment to return all FCF to shareholders, the number of shares outstanding has shrunk by nearly 50% since 2004.
The question now is: what will the company deliver in the year of covid-19?
In spite of the covid-19 driven economic headwinds in Q2, TXN delivered an admirable quarter:
Source: Q2 EPS Report
As the graphic above indicates, a 31% decline in embedded processors revenue (think automotive) led to an overall revenue decline of 12% yoy. Yet less capital spending and tight cost controls enabled the company to actually increase EPS by 9% yoy to $1.48/share. FCF generation was strong in Q2: $1.59 billion (49% of total revenue and an estimated $1.71/share). As a result, the company continued to meet its commitment to shareholders by delivering $1.71 billion to shareholders in a roughly 50/50 split between dividends and share buybacks. The average number of shares outstanding fell to 927 million – down 2.7% as compared to Q2FY19.
Analog revenue declined only 4% and continues to be the main driver of both revenue (75%) and operating profits (86%). On the top-line, the main drag was clearly automotive. Automotive was down ~40% sequentially and down over 40% compared to a year ago. Excluding automotive, TI was up 8% sequentially and down 3% versus a year ago. However, management said the automotive market appears to have bottomed in May as North American and European assembly plants resumed operations.
The company continues to benefit from the move to 300mm wafers, which have a 40% cost advantage as compared to chips from the 200mm wafers most of its competitors still use. TXN has two 300mm wafer fabs in operation and is building a third line in Richardson, Texas. As VP & CFO Rafael Lizardi said on the Q2 conference call:
And then over the longer term, of course, 300 millimeter and continuing to add revenue on 300 millimeter has a structural cost advantage that helps our margin just continue to be a tailwind on margins. It has been and will continue to be.
So, despite covid-19, so far, so good for Texas Instruments in 2020.
TI’s outlook for Q3 is for revenue in the range of $3.26 billion to $3.54 billion, and earnings per share between $1.14 and $1.34. The midpoint of those ranges – revenue of $3.4 billion, EPS of $1.24 – compares to $3.77 billion in revenue and EPS of $1.49 in Q3 of 2019. As a result, yoy comparisons next quarter likely won’t be favorable, even if they were to come in at the high-end of the ranges. That said, note the midpoint of revenue would be above Q2’s revenue of $3.24 billion.
In addition to its strength in analog chips, going forward TI will likely benefit from exposure to the medical and work-from-home (“WFH”)technology markets. The companies ability to deliver a strong Q2 despite the down-swing in automotive, was likely due to its ability to ramp up chip supplies to the surging WFM, video streaming, and online gaming markets from its highly efficient in-house state-of-the-art 300 mm manufacturing facilities.
TI closed the quarter with a strong balance sheet featuring $5.0 billion in cash and short-term investments and net debt below $2 billion.
Risks include continuing softness in the automotive market due to covid-19’s impact on the domestic and global economies. In addition, TI is facing significant competition from Maxim Integrated Circuits (MXIM) in analog, Broadcom (AVGO) in various connectivity segments, and Microchip (MCHP) – mostly in microcontrollers. In addition, I suspect TI’s “other” category may be soft due to its mobile calculator business, which may have seen a downturn due to virtual schooling.
Summary & Conclusion
Source: Seeking Alpha Charting Tool
As can be seen by the chart above, TI has been left in the dust by the iShares PHLX SOX Semiconductor Sector Index ETF (SOXX), and is trailing some of its peers as well. With current forward EPS estimates of $5.14, and a forward P/E=27.5, the company appears fairly valued here. If you are looking to invest in a semiconductor maker, I would keep TXN on your Watch List and consider investing if/when there is a bit more clarity on an automotive market comeback. That’s because one thing is very likely: TI will continue to direct almost all of its FCF back to shareholders. That’s not only very uncommon these days, it is very refreshing.
Disclosure: I am/we are long AVGO. 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: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.