Chipmakers have been a red-hot sector for what now seems like forever. In the last five years, the Philadelphia Semiconductor Index has advanced nearly 200%, versus the S&P 500's total return of 90%. Perhaps the most notable chipmaker during this period is GPU-maker NVIDIA, as its stock increased 1,800%.
Against that backdrop, you can forgive investors for overlooking other companies in the sector, which is exactly what has happened to Texas Instruments (TXN +19.43%). It's somewhat understandable, as Texas Instruments' key product, analog chips, don't elicit the same reaction from the technology community as NVIDIA's GPUs with their artificial intelligence (AI), data center, and gaming-focused applications.
However, overlooked companies can often provide phenomenal returns below the radar. And that's just what Texas Instruments has done, slightly outpacing the semiconductor industry's return by advancing 227% during this same five-year period.
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Strong growth and improving margins will lead to more cash return
While it certainly did not post the same growth rates as NVIDIA, Texas Instruments is outperforming the overall market. Last quarter, the company reported a 11.4% year-on-year revenue increase. The quarter marked the fourth out of the last five that the company has posted double-digit increases. In fiscal 2017, the company reported an 11.9% increase, a higher revenue growth rate than the prior year versus the S&P 500's 7% increase.
Perhaps more important, Texas Instruments is growing its margins in the process. Operating income increased 3.7% over the prior-year quarter. The biggest driver was the company's transition from 200-millimeter analog production to 300-millimeter, a change that lowers the chip production costs by 40%. And in sales mix, higher-margin analog chips comprised a larger percentage of sales during the quarter.
The combination of increased margins and revenue have boosted Texas Instruments' free cash flow. And the company's shareholder-friendly management team has stated in no uncertain terms that it expects to return essentially all its free cash flow to shareholders. In the last 12 months, Texas Instruments has returned $5.1 billion in share repurchases and dividends, roughly equivalent to 4.5% of its current market cap.
Texas Instruments could be huge in the Internet of Things
Expect Texas Instruments' free cash flow to continue to grow. Although analog chips may be boring compared to chips used in AI and gaming applications, it's likely that the former will have a huge role in the Internet of Things (IoT), as converting analog signals to digital will be a key part of the data collection and monitoring feedback processes needed to automate residential and industrial objects.
To date, the IoT has progressed at a slower rate than many have predicted. But there's reason to expect growth to rapidly pick up in the next few years as the initial focus of the industrial IoT has turned to autonomous vehicles, with numerous automakers and technology companies in various stages of real-world testing.
Market research firm IC Insights expects analog chips will be the fasting-growth chip category, averaging 6.6% annual growth between 2017 and 2022 on the back of analog automotive chips, with an expected 15% growth for auto analog this year. Texas Instruments is well situated here and in industrial IoT in general, with 35% of its 2017 revenue attributable to industrial applications and 19% to automotive applications.
Texas Instruments may not have the appeal of other chipmakers, but the company has quietly reduced more than 43% of its shares outstanding since 2004 and provided investors with 14 years of consecutive dividend increases. Investors should expect both to continue.
