5 Green Flags for Texas Instruments' Future

Texas Instruments (TXN 1.25%) posted a strong second-quarter report on July 26. The analog and embedded chipmaker's revenue rose 14% year over year to $5.21 billion, exceeding analysts' expectations by $560 million. Its net income increased 19% to $2.29 billion, while its earnings per share grew 20% to $2.45 and topped the consensus forecast by $0.33 per share.

Those headline numbers were impressive, but a deeper dive into TI's report reveals five other green flags that make it a great buy right now.

Image source: Getty Images.

1. Texas Instruments had another quarter of stable growth

TI produces a wide variety of analog and embedded chips for the automotive, industrial, personal electronics, communications, and enterprise sectors. That broad diversification enables it to avoid cyclical slowdowns in narrower markets like smartphones and PCs.

TI generated 77% of its revenue from its analog chips during the second quarter. Another 16% came from its embedded chips, while the rest came from other products. Here's how those two core businesses fared over the past year, even as other chipmakers grappled with cyclical challenges.

Data source: Texas Instruments. YOY = year over year.

2. The auto and industrial markets are growing

Most of TI's growth came from the auto and industrial markets, which together accounted for 62% of its revenue last year. The post-lockdown expansion of those two markets insulated TI from slower smartphone sales, which dragged down chipmakers like Qualcomm (QCOM 0.73%), as well as softer demand for new PCs, which cast dark clouds over Intel (INTC -0.38%), Advanced Micro Devices, and Nvidia.

TI didn't disclose the exact growth rates of either end market in the second quarter, but it said its industrial revenue increased by the "high-single digits" year over year and that its automotive revenue rose "more than 20%." That robust growth easily offset the weaker growth of its personal electronics business, which includes its chips for mobile devices.

3. Waning headwinds in China

In TI's first-quarter earnings report from late April, the chipmaker warned that it would face COVID-19-related disruptions in China -- where it generated about a quarter of its revenue last year -- and reduced its Q2 guidance by about $500 million to reflect those uncertainties.

But in its second-quarter report, TI said those headwinds peaked in April and waned in May and June, and its Chinese customers quickly ramped up their orders to make up for lost time. As a result, TI barely experienced a meaningful slowdown in China, which enabled it to actually surpass analysts' revenue estimates by more than $500 million for the full quarter.

4. Rock-solid margins

TI manufactures its own analog chips while outsourcing its embedded chips to other foundries. It's been upgrading its plants from 200-millimeter to 300-millimeter wafers over the past several years, which reduces the costs of its unpackaged parts by approximately 40%.

Those upgrades have consistently boosted TI's gross and operating margins, and its free cash flow (FCF) margin remains comfortably between 30% and 40%, giving it plenty of room to keep repurchasing its shares and raising its dividend.

Data source: Texas Instruments. *Trailing 12 months.

5. The CHIPS Act

Finally, the recent passage of the CHIPS Act, which grants up to $52 billion in subsidies and tax breaks to U.S. chipmakers, will also generate tailwinds for TI.

The CHIPS Act will only award those subsidies to integrated device manufacturers (IDMs) like TI or Intel that manufacture their own chips instead of "fabless" chipmakers that outsource them to other foundries. Earlier this year, TI said it would boost its capital expenditures to about $3.5 billion annually, or a mid-teens percentage of its projected revenue, over the following four years to upgrade its 300-millimeter plants. It also plans to keep its capex elevated at about 10% of its revenue from 2025 to 2030.

TI reiterated those ambitious plans during the conference call, but the CHIPS Act could soften the blow and ensure that it remains on track to expand its domestic fabs, which include its Richardson, Texas, fab this year; its Lehi, Utah, fab in 2023; and its Sherman, Texas, fab in 2025.

Still cheap and still evergreen

For the third quarter, TI expects its revenue to rise 6%-14%, and for its EPS to increase 8%-21%. For the full year, analysts expect its revenue and earnings to climb 10% and 8%, respectively, which are solid growth rates for a stock that trades at 19 times forward earnings.

Many aspects of TI's business are cyclical, but I believe it's an evergreen stock. Between 2004 and 2021, it raised its dividend every year, reduced its share count by 46%, and grew its FCF at an average annual rate of 12%. It's also generated a total return of more than 550% over the past 10 years -- and it could still have plenty of room to run over the next few decades.