Intel (INTC 0.64%) and Texas Instruments (TXN 5.64%) are both considered slow growth plays in the chipmaking industry. Intel generates most of its revenues from high-end chips for PCs and data centers, while Texas Instruments sells cheaper analog and embedded chips for a wide variety of industries.
Last October, I compared Intel to TI and concluded that Intel was the better buy, based on its lower valuation, higher dividend yield, and growth potential in adjacent markets. My call was wrong -- since that article was published, shares of Intel have slipped 5%, while shares of TI have rallied 10%. Let's take a closer look at why TI outperformed Intel over those few months, and whether or not that situation could change this year.
Image source: Pixabay.
Why Intel disappointed investors
Intel has posted positive year-over-year sales growth over the past five quarters. Unfortunately, much of that growth was overshadowed by the ongoing weakness of its data center business, which accounted for 29% of its top line in 2016.
The unit posted 8% sales growth during the year, but that was well below the 15% annual growth rate that the company was previously shooting for. That slowdown was mainly attributed to sluggish chip upgrades from enterprise customers. The unit's operating income also fell 4% in 2016 due to heavier spending on the ramp up of its 14nm chips.
Meanwhile, demand for Intel's PC chips remains sluggish due to a five-year long slump in PC shipments. That was mainly caused by older PCs lasting longer and the rise of tablets and smartphones as primary computing devices. Intel's Client Computing revenues, which mainly come from PC chip sales, rose just 2% in 2016 and accounted for 55% of its top line. However, the unit's operating income rose 30% for the year thanks to lower spending, a richer product mix, and various cost improvements.
Intel's moves into adjacent markets have yielded unpredictable results. The Internet of Things (IoT) group posted double-digit sales growth in 2016, but its non-volatile memory revenue dipped 1% due to weaker demand at the beginning of the year, offsetting stronger demand in the second half. However, that unit should strengthen throughout this year on rising memory prices.
Why TI impressed investors
Texas Instruments has posted year-over-year sales growth for three straight quarters. Its well-diversified portfolio of analog and embedded chips -- which are sold to the industrial, automotive, wireless infrastructure, and consumer electronics markets -- has prevented it from being heavily exposed to single slow-growth markets like Intel.
Over the past year, robust sales of chips for the industrial and automotive markets -- which generated half of TI's revenue in 2016 -- offset softer demand from the wireless infrastructure and consumer electronics businesses. In the past, TI's biggest concentration risk came from a large customer, which accounted for 11% of its revenue in 2015. But that exposure has since waned -- during last quarter's conference call, TI declared that no single customer accounted for over 10% of its revenue in 2016.
In addition to a well diversified business, Texas Instruments prioritizes cheaper chips with high margins over higher performance ones with lower margins. That's why TI abandoned higher-performance markets, like mobile application processors and baseband modems, and shifted its production from 200mm to 300mm wafers, which reduced its production costs by 40%. As a result, TI's gross margin has been rising as Intel's has been falling.
Source: YCharts
Top and bottom line comparisons
TI's total revenues rose 3% in fiscal 2016, compared to Intel's 7% growth last year. But looking ahead, analysts expect TI's revenues to grow 5% in 2017 and outpace Intel's 1% growth. That forecast assumes that Intel's PC and data center businesses will remain wobbly despite the launch of new chips, and that TI's automotive and industrial strength will persist with higher sales of connected cars and machinery.
On the bottom line, Intel's earnings rose 9% on a non-GAAP basis in 2016, but fell 9% on a GAAP basis due to currency headwinds and other expenses. Analysts expect its non-GAAP earnings, boosted by buybacks, to rise 3% this year. TI's net earnings rose 23% last year, thanks to its margin expansion and buybacks, and analysts expect its earnings to rise another 10% this year. Both companies have plenty of cash to spend on dividends -- but TI's forward yield of 2.6% remains slightly lower than Intel's yield of 2.9%.
The valuations and the verdict
TI currently trades at 25 times earnings, which is much higher than Intel's P/E of 17 and the industry average of 22 for broad line semiconductor companies. But that premium indicates that investors are more willing to invest in TI's better diversified business model of cheap higher-margin chips than risk exposure to Intel's sluggish PC and data center markets. Some of Intel's moves into adjacent markets are promising, but those businesses are still too small to offset slower growth at its two core businesses.
I'm personally not a fan of either stock at their current prices. TI's growth looks more promising than Intel's, but the stock is too pricey and its dividend is too low to justify a purchase. Intel is cheaper and has a higher dividend, but there are better income plays on the market now with higher yields and lower valuations.
