Texas Instruments (NASDAQ:TXN) 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.

Young woman making it rain with dollar bills.

Image source: Getty Images.

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:

  1. 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.
  1. 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.
  1. 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.

Billy Duberstein owns shares of Texas Instruments. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.