Texas Instruments (TXN +0.67%) is one of the most shareholder-friendly companies around, due to its emphasis on prudent capital allocation. This focused policy and transparency have paid off in recent years, as Texas Instruments posted strong growth, while also returning large amounts of cash to shareholders in the form of dividends and share repurchases.
Recently, Texas Instruments made some updates to its capital allocation policy for 2018, tweaking some of its annual targets. Here are the important changes, and what they could mean for shareholders in the upcoming year.
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Long-term strategy update
The first change the company made was to write out its long-term objectives for each capital allocation category, not merely give a numerical annual target. The short sentences explain the rationale behind each target so that shareholders will know how the numbers fit into the company's overall strategy. Here are the updated policies:
|
Metric |
Long-Term Objective |
|---|---|
|
Free Cash Flow (FCF) Generation |
Maximize long-term growth of FCF per share. |
|
Capital Expenditures |
Invest to support new technology development and revenue growth. Extend low-cost manufacturing advantage, including 300-mm wafers, while maximizing long-term FCF/share. Recognize it may run higher if there is an opportunity to extend long-term manufacturing advantage. |
|
Inventory |
Maintain high levels of customer service, minimize inventory obsolescence, and improve manufacturing asset utilization. Will vary based on the percent of direct revenue, market conditions, and consignment levels. |
|
Cash Management |
Provide necessary liquidity in all market conditions. Recognize there may be a drawdown of cash. |
|
Pensions |
Be fully funded on a tax-efficient basis. Have annual FCF reflect what is available to owners by minimizing one-shot calls for cash, unless there is a P&L or cash advantage. |
|
Debt |
Increase rates of return with some leverage on balance sheet when the economics make sense. Avoid concentrated maturities and ensure strategic flexibility. |
|
Cash Return |
Return all FCF via repurchases and dividends. Recognize there may be times for strategic buildup or drawdown of cash. |
|
Dividends |
Provide a sustainable and growing dividend to appeal to a broader set of owners. |
|
Repurchases |
Accretive capture of future FCF for long-term owners. |
Source: Texas Instruments Investor Relations.
2018 targets versus 2017
The company also provided actual 2017 results versus targets, as well as new targets for 2018. Here is what Texas Instruments targeted in 2017, what it achieved, and the new targets for the upcoming year:
|
Metric |
2017 Target |
2017 Actual |
2018 Target |
|---|---|---|---|
|
Free Cash Flow Generation |
20%-30% of TTM revenue |
31.2% |
25%-35% of TTM revenue |
|
Inventory |
105-135 days |
134 |
115-145 days |
|
Cash Management |
10% TTM revenue + NTM dividends + NTM debt |
101% |
10% TTM revenue + NTM dividends |
|
Pensions |
Fully fund on a tax efficient basis |
Fully funded |
Fully funded |
|
Debt |
When economics make sense |
$4.1 billion at average 2.05% |
When economics make sense |
|
Capital Expenditures |
About 4% revenue |
4.6% |
About 4% revenue |
|
Cash Return |
FCF + proceeds from exercises-net debt retirement (TTM) |
90% |
All free cash flow |
|
Dividends |
50%-80% trailing 4 years' average FCF |
57% |
40%-60% of current year FCF |
|
Repurchases |
Cash return target-dividends |
84% |
Free cash flow-TTM dividends |
Source: Texas Instruments Investor Relations. TTM = Trailing 12 months. NTM = Next 12 months.
The major changes in 2018 are:
- Free cash flow margin: Increased by 5% from 2017 guidance, which management attributed to U.S. tax reform. It should be noted that the actual 2017 free cash flow came in above the high end of the company's 2017 guidance, despite spending more on capital expenditures this year than forecast. The free cash generation of the business is already incredibly high at 31.2%, which management attributes largely to its strong end markets and 300-mm wafer production capacity. As most of its competitors produce chips on smaller 200-mm wafers, Texas Instruments has a 40% cost advantage at production, which translates into an 800 basis-point gross margin advantage.
- Inventory: The company is targeting slightly greater inventory in 2018, in order to maintain higher levels of customer service, as well as to get greater visibility into end demand. The end inventory levels are only slightly elevated in the forecast, so I don't think this is anything particularly to worry about.
- Dividend payout: The dividend policy has been clarified to 40% to 60% of current-year free cash flow, changed from 50% to 80% of trailing four years' free cash flow. Management did this to simplify the metric for analysts and shareholders. Texas Instruments' current dividend payout ratio is 46.7%.
All in all not much has changed at Texas instruments -- only that it anticipates better margins, more free cash flow, and even greater transparency with shareholders. For those looking for safety in this volatile market environment, Texas Instruments may fit the bill.
