Coming out of a dreadful year for vehicle sales (research points to a global double-digit percentage plunge for vehicles sold in 2020), the new year could mark a return to year-over-year growth for the auto industry. Plus, "connected car" tech is in higher demand than ever before, and electronic components -- now comprising some 40% of a car's cost -- are only expected to continue rising.
For auto suppliers like NXP Semiconductors (NXPI 3.79%) and Texas Instruments (TXN 3.18%), this potential dual tailwind would be great news. I think both are a solid bet on the auto industry long-term, but one looks like the better buy right now.
NXP: Making personal transportation a connectivity hub
NXP is a specialist in connectivity semiconductors for a number of industries, including for 5G mobile networks, but the auto industry is by far its largest end market. Even in a bad year for its manufacturing partners, revenue derived from automotive was well over 40% of NXP's total revenue.
Because of the decline in auto sales in the last year, NXP's revenue was down 7% year over year through the first nine months of 2020. However, top-line results are rallying quickly as economic activity gets back to normal, and auto manufacturers are implementing more of NXP's tech -- everything from advanced driver assist systems (ADAS) for increased safety and vehicle autonomy to electric vehicle powertrain management to infotainment and mobile connectivity. And as sales recover, free cash flow (basic profitability measured as revenue minus cash operating expenses and capital expenditures) is on its way to recovering too.
Coming out of a global economic crisis, this chipmaker is in decent shape. Cash and equivalents totaled $3.57 billion and total debt $9.36 billion at the end of September 2020. Subsequent to its last quarterly update, NXP redeemed some of this debt for $1.83 billion using cash on balance. As it continues to recover with the global economy, NXP is set to become a leaner cash-generating machine paired with gradual growth potential from its portfolio of connectivity chips.
This could also be a solid income stock in the making. While a dividend currently yielding 0.9% a year isn't much to write home about now, NXP just started doling out this payment in 2019. And the payout used up less than a third of free cash flow generated through the first nine months of 2020. There's thus plenty of room for NXP to grow its shareholder return over time. Trading for just under 29 times trailing 12-month free cash flow as of this writing, this is a solid bet on a global auto industry rebound and vehicle technology and connectivity growth, paired with a small side of dividend income.
Texas Instruments: The old stalwart in reliable income growth
While NXP is an emerging income stock, Texas Instruments is an old reliable in this department. The company currently pays a 2.3% dividend yield and has raised the payout every year since 2004. With the dividend together with the company's share repurchase program, TI has the goal of returning all of its free cash flow generated to its shareholders.
And like NXP, it hasn't been an easy year for TI. It also had to deal with the slump in the auto industry and will benefit from a recovering global consumer rebound in the years ahead. Nevertheless, even a bad year of financial performance for TI would be a banner one for many other firms. Revenue and free cash flow were down 6% and 15% respectively through the first nine months of 2020 compared with 2019, but free cash flow profit margin remained at an enviable 34%. This performance prompted a 13% dividend payout hike last autumn as TI's end markets make a comeback.
TI will also benefit long-term from new vehicle technology and electronics components comprising a greater share of production costs. It continuously invests in research and development of new chip designs -- similar to NXP with ADAS and powertrain components, along with other semiconductors for the communications and consumer electronics industries. It also has a best-in-class manufacturing operation that has a long track record of getting more efficient over time. Free cash flow averaged an 11% per year increase from 2004 through 2019.
At the end of September 2020, TI had $5.52 billion in cash and short-term investments and only $6.80 billion in debt. As of this writing, shares can be bought for 31 times trailing 12-month free cash flow. For a proven leader in chipmaking and shareholder return, it's not a terribly unreasonable premium.
Which is the better buy?
Texas Instruments' stock currently trades for a premium to NXP Semiconductors', but the higher price tag is worth it in my book. TI has a proven track record of profitable growth. And while NXP gets my nod as a solid bet on a recovering auto industry and global consumer in general, TI will also get a similar bump in the years ahead as the effects of the pandemic wear off. TI also has a stronger balance sheet to work with as it develops next-gen semiconductor tech and improves on its manufacturing processes. NXP is worth considering, but Texas Instruments looks like the better buy to me at this juncture.