Key Takeaways

• Texas Instruments doesn’t get the hype and love that Nvidia and ASML do, but it nonetheless has a strong business whose earnings and revenue potential are likely underestimated by consensus.
  
• The company’s core end-user segments are in industrials and autos. The shortages in these areas and the competitive advantages in production and customer experience seems like a winning formula.
  
• The company has less single-point dependency and, given its amazing market channels and deep customer relationships. It simply has more opportunity per customer than peers because of its model.
  
• Texas Instruments is an old company but is slated to capitalize handsomely from modern trends like the rise of EVs, electrification across industries, and the rise of automation in factories.
  
• The company reduced the share count 46% between 2004 and 2020. We believe the dividends and shareholder-friendly management focused on long-term capital appreciation make this a good one to hold for a long time.
  

“The model I like to sort of simplify the notion of what goes on in a market for common stocks is a pari-mutuel betting system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there, and bets and the odds change based on what is best. That’s what happens in the stock market.” -Charlie Munger, Art of Stock Picking

Many folks have heard the tired tripes of the stock market being nothing more than a “casino.” The stock market may have some similarities to casinos that are superficial, but we generally see casinos as a lousy metaphor for stocks. This doesn’t mean that the stock market isn’t tangentially related to gambling in some ways. It is just more similar to a different kind of gambling.

While there has been a great focus lately on those, who have achieved extraordinary returns in “lottery ticket” type stocks that paid off huge and had prodigious growth but had long odds, in the beginning, anyone at the horse or dog track can tell you a sole focus on these types of stocks is a losing strategy.

We would say long-shots with big payoffs have a place in any portfolio: these are analogous to dark horses (those that pay the best odds because betting markets have indicated they are long shots). If you bet only dark horses, you’d have to be quite lucky indeed to win. The optimal strategy in pari-mutuel betting is to have a mixed portfolio of bets comprised of horses with good odds of winning with some dark horses scattered in. This gives you a better chance of a higher return.

Unlike most casino games, pari-mutuel betting does not involve betting against a house with an advantage but involves bets against other gamblers. The odds are set by the gamblers themselves, just as stock prices are influenced by investors’ buying or selling stocks. Of course, if you do the work and find out a horse is stronger than the odds would indicate, this is always a great strategy.

Very much like equity, the odds (which would be analogous to price in this case) are set by sharing the pool among all winning bets. This is tangentially similar to how equity prices are set, of course; since the value of equities are primarily based on future cash flows, the math and modes of analysis can get more complex.

Texas Instrument Is Not a Dark Horse. It’s A Solid Bet

The unique folklore of the digital age and the American garage being a center of innovation was heavily influenced by the earliest harbingers of the digital revolution, of which Texas Instruments is one. The company helped take the world from cumbersome vacuum tubes to transistors. Its analog chips comprise the vast majority of its revenue. Embedded chips are a promising and growing area with a smaller footprint.

Not only did the company pull off some incredible feats necessary for the human advancement we often take for granted, like building the first handheld calculator (calculators are less than 2% of revenue, by the way), it also had a very prominent role in the defense space including Project Vela, which monitored the Soviet Union’s underground nuclear tests.

The company was officially founded in 1951, but its origins go back further. Still, it has modern relevance. If there is one company that will benefit from the pricing power afforded by the shortage in the auto industry, it is probably Texas Instruments. This shortage will not be abated anytime soon!

So, its technological achievements at the cutting edge of technology are certainly a part of the company’s history. Though growth has slowed, the recurring revenue and milder CAPEX requirements of the niche it has carved out have plenty of desirable characteristics to compensate for this reality. The prolonged and recurring revenue profile of the company’s core products makes it more similar to a SaaS company than to leading-edge semi companies in some ways. It is an attractive business to own by many metrics, and we see no reason why it won’t continue to be.

It is a much more mature play than some of the semiconductor leaders. Nonetheless, with maturity comes quality and consistency in the case of this firm. We also think consensus may be under on growth potential given the extraordinary times. The company has a higher inventory than its peers, which should prove advantageous. Its dominant market position also allows it to spend more on an absolute basis on CAPEX while diverting less of a percentage of total revenue than competitors.

Today, however, as opposed to some of the higher growth semiconductor names at the leading edge of the extremely complicated and incredibly tiny modern semiconductors, the company has lucrative niches of non-leading generations of chips, like the company’s 300 mm platform. Leading-edge semiconductors last for 18 months, whereas analog semiconductors can be used for decades. This means Texas Instruments is insulated from the back-breaking and competitive capital intensity that the digital side of the industry is known for.
Suppose you also factor in the fact that this management team and culture has a solid history of delivering lucrative returns to shareholders. In that case, you can begin to see why this can be one of your “set-and-forget” stocks despite its high valuation. We believe the valuation has been increasing for good reasons reflecting economic advantages on both the supply and demand side.

The management of this company has their planning and timelines on a longer timeline than typical firms. With maturity and focus have come the steadiness and robust FCF growth required to take advantage of a once-in-a-generation tailwind that has come from shortages, and which transformed one of the company’s central liabilities, its higher proportion of fixed costs due to a greater degree of vertical integration than its competitors.
You see, fixed costs were more problematic in the pre-COVID-19 world because your costs didn’t go down when demand did. This is good news for this company that has the growth rates of a mature company, is that margins and revenue are both likely to exceed expectations given the persistent nature of auto industry shortages. Texas Instruments has the manufacturing capacity and high inventory to benefit from the unique situation the analog side of the chip industry finds itself in.

A Little Tour of The Semiconductor Shortage

Semiconductor shortages may have only been in the news recently, but the factors leading to the situation we now find ourselves in has been building for years and will take years to resolve. The pandemic had a very volatile effect on an industry known as just-in-time, fragile supply lines and a high degree of cyclicality. Luckily, Texas Instruments doesn’t fit this industry stereotype and is probably the best example of the industry’s other extreme.
COVID-19 is obviously a primary source of consternation amongst global supply lines in all sorts of advanced manufacturing but particularly with semiconductors. The other major factor driving shortages was the decline in trans-Pacific trade relations. Here too, Texas Instruments has a significant advantage over much of the industry and is more insulated from China-risk than most competitors.

Autos and industrials, where Texas Instruments derives most of its revenue, have longer cycles than the ultra-fast computing and mobile segments. The auto industry, in particular, has very long lead times, and the semiconductor content in the emerging area of EVs and autonomous driving is rising for the foreseeable future.
The semiconductor shortage at the leading edge of the technology is distinct from the one affecting the auto most acutely affecting the industry (although the industry is affected by both). The bulk of auto chips used are of earlier generations, like the kind Texas Instruments uses. It is slated to benefit from this secular tailwind, which makes outperformance of consensus expectations likely in our estimation.

Long story short, there are many converging tailwinds for Texas Instruments, and we see above-consensus growth occurring at the firm based on supply and demand-side factors. This, coupled with a mature and highly competent management team with an industry-leading sales force at its disposal, a relatively capital-light model, and a stellar record on buybacks, dividends, and capital allocation, make us think this is a great name to put Texas Instruments in your portfolio. Keep it for a long time. We don’t think you’ll be disappointed.

Is Texas Instruments The ASML of Analog?

We recommended ASML 1.83%  in this column due to its technological monopoly and formidable competitive moat in the leading edge EUV technology. We understand that the semi-industry is confusing and highly competitive, but it’s important to understand Texas Instruments is a very different animal. Despite the very different economic environments between digital and analog semis, if ASML has a good analog (no pun intended) on the analog side it is Texas Instruments.

Computing and wireless make up the lion’s share of global semiconductor demand at 65%, but autos, industrials, and wired communications make up nearly a quarter of global sales. This is where Texas Instruments is the leading player. You can think of analog chips as regulating functions in real-world applications like temperature, speed, sound, and electrical current. Digital semiconductors produce the binary information used by computers of all stripes.

The analog chips that TXN dominates have different economic characteristics than the more flashy semi names, specializing in digital integrated circuits you may be more familiar with. Some of the critical differences are below, and they also show why these different sides of a complex industry can complement each other when held together in a portfolio.

It should be noted that given the extraordinarily global and competitive nature of semiconductors, true vertical integration is currently impossible, and this is part of the reason for what Uncle Sam and Intel are doing in the Arizona desert. However, Texas Instruments is probably the closest to it in the industry, and the advantages in savings are apparent; we also think there’s major intangible value associated with this reality too.

Texas Instruments has a culture and management team that knows how to play its strengths. The company has already demonstrated that its business model and in-house production capacity is a superior model in a world where dispersed and fragile supply chains are strained to say the least. Simply keeping up with manufacturing and keeping inventories filled is a major advantage in this highly competitive industry of semiconductors. The company’s focus on a superior customer experience and longer revenue cycle also help.

As you can see, this isn’t just lip service. The Texas Instruments main 300 mm wafer cost is approximately 40% less than the primary alternative product. This is not a negligible level of savings in a world where corporate survival is increasingly defined by belt-tightening, and advanced manufacturing suffers setbacks from many vantage points. The company built a solid and resilient infrastructure. We think this is responsible for multiple expansion, along with the increased pricing power the firm has in its two key end markets, which both should be beneficiaries of pent-up demand.

Texas Instruments has more manufacturing capacity than any analog chipmaker. The company produces more chips on larger wafers and simply can make a lot more than competitors. We see this advantage as having a material impact as the auto chip shortage shows no signs of abating. Texas Instruments operates in a fragmented market as the dominant player. It will likely be able to grow at a far higher rate in analog by virtue of the vital fact that it has higher inventories than peers.

While Texas Instruments dominates the Analog IC market, it lags in fab capacity of some of the big boys. The nature of analog production means it is inherently lower volume compared to digital. Still, we’d like to show you a larger chip producer like Intel and their complicated supply chain relative to that of Texas Instruments. This helps to demonstrate the advantage the company has in a post-COVID reality where the more complex a supply chain, the more likely it is to be inhibited by any number of kinks.

We believe the relative simplicity of Texas Instruments’ supply chain and their superior process for packaging, design and integrating their products into end uses is a major advantage that will continue to win over more and more customers. The need for the vital analog chips in areas like power management (positive for ESG) and other real-world sensors for things like autonomous driving and the rise of EVs should be considerable tailwinds. As the fourth industrial revolution unfolds and a world with more and more sensors feeding more and more data, it is easy to see how consensus could have underestimated the revenue potential of this stalwart firm. With anomalous pricing pressures in the firm’s favor its easy also to see underestimating EPS could also be possible. We are biased to the upside.

Risks And Where We Could Be Wrong

We specifically selected this stock because we think it is a solid bet. We believe the competitive pressure in the company’s niche would be tough for anyone to assail. The long-term thinking and demonstrated track record as a top S&P stock by key metrics give us great confidence in this name. Our new Global Head of Technical Strategy, Mark Newton, also advises that he believes the stock is in a technical breakout. We’re happy to have “air cover” again, and we’re all happy to have him on the team. His work speaks for itself, but get ready for some first-rate technical analysis.

We think a crucial risk could be the higher level of fixed costs Texas Instruments has, which have more recently been a strength given demand dynamics. Texas Instruments is concentrated in end-users with cyclical exposure. However, the long revenue profile of its products helps mitigate this risk. There is, of course, some pricing risk given that it is near all-time highs, but we’d say the fundamentals argue it is a buy. Their lesser embedded chip segment could also experience significant growth, which could materially add to the stocks appreciation potential if revenue in the area comes in higher than consensus expects in the next five years.

Consumers care about performance, breadth of offerings, and support. Texas Instruments is a leader in all three areas. It is always possible they lose their edge and lose market share to a younger, more vibrant firm. The company’s best-selling product is only 1% of revenue, so the stock has some natural diversification built into it that stands in stark contrast to the leading edge of the industry. We believe a credit comparison against key industry peers gives a good picture of risk relative to peers.

The company’s established profile and long-term thinking have also led to its superior credit profile compared to many peers. There is always a risk with any company that they don’t allocate capital in the most efficient way, or they fall behind competitively. We’d say the lower CAPEX rate of Texas Instruments relative to peers does potentially exacerbate this risk. Dividend growth has slowed which could deter some who normally would have bought the name. This seems temporary to us until the current boon can filter its way through the business.

Still, as we mentioned, risk in this name is also mitigated by the nature of the analog industry and the fact that Texas Instruments isn’t as subject to competitive innovation in the areas it dominates as many in the semiconductor industry. Not only does it have a formidable moat, not many are attacking its edge directly unlike many industry players. This is an outstanding stock with a great business model and management knows how to deliver value over the medium and long term. This is not a name to trade; it is a name to own.