Texas Instruments is a very profitable company because it is very efficient at using resources. A quick look at the company’s historical return on equity (ROE) trend highlights this efficiency. In the last five fiscal years, ROE has grown from 35% in 2016 to 69% in 2021.
This improvement in efficiency is even more impressive when breaking down the ROE trend into a DuPont analysis, separating it into three different parts: net profit margin, asset turnover, and equity multiplier. An increase in ROE is ideal when it is driven by increases in profit margins and asset turnover as opposed to leverage (equity multiplier).
When looking at the chart above, we can see that although the equity multiplier increased (meaning the company took on more leverage), the net profit margin grew very rapidly as well. Another way to look at it is that TXN took on 25% more leverage to grow its profit margin by 55.6% more.
This suggests that the management team is highly effective at allocating capital and creating value for shareholders. We’re neutral on the stock.
Growth Catalysts
When looking at the numbers above, it is important to remember that TXN has a strong sales boost in 2021 due to the chip shortage. Revenue grew 26.9% in 2021, way higher than any other year in the past decade.
The chip shortages could continue to provide a short-term boost for the industry in 2022 as well. However, don’t expect similar growth to that of last year. In fact, analysts are expecting revenue growth in the high single digits for 2022.
Nonetheless, secular growth trends still remain for the industry as a whole. As technology advances, more chips will be required to produce new products. Indeed, the industry is expected to grow at a compound annual growth rate of 7.6% from 2021-26, providing a tailwind for Texas Instruments.
Furthermore, the company regularly repurchases its shares which tends to boost share prices. Consistent share repurchases have a dramatic difference in share count over the long run. In 2012, the share count was 1.132 billion, whereas, in the most recent quarter, it was only 924 million.
Since the company generates plenty of free cash flow, it will likely continue buying back shares for many years to come.
Valuation
To value TXN, we will use a single-stage DCF model because its free cash flows are not very predictable, and single-digit growth rates are more likely going forward.
For the terminal growth rate, we will use the 30-year U.S. Treasury yield as a proxy for expected long-term GDP growth.
Our calculation is as follows:
Fair Value = Average FCF per share / (Discount Rate – Terminal Growth)
$182.35 = $6.82 / (0.06 – 0.0226)
As a result, we estimate that the fair value of Texas Instruments is approximately $182.35 under current market conditions.
Wall Street’s Take
Turning to Wall Street, Texas Instruments has a Moderate Buy consensus rating, based on seven Buys, 11 Holds, and two Sells assigned in the past three months. The average Texas Instruments price target of $202.81 implies 22% upside potential.
Final Thoughts
Texas Instruments is a very high-quality company that has efficiently grown its profit margins over the years. The industry is growing at a healthy pace and should act as a long-term tailwind. In addition, the company is trading below our estimated fair value and analysts’ price target.
Nevertheless, we remain neutral because our own estimate doesn’t provide us with enough margin of safety to comfortably take a position.
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