Is Texas Instruments Stock a Buy Now?

Texas Instruments (TXN 1.77%) posted its third-quarter earnings report on Oct. 25. The chipmaker's revenue rose 13% year over year to $5.24 billion, which beat analysts' estimates by $100 million. Its net income increased 18% to $2.30 billion, or $2.47 per share, which also cleared the consensus forecast by 8 cents.

But for the fourth quarter, TI expects its revenue to decline between 1% and 9% year over year and for its earnings per share (EPS) to drop between 7% and 19%, compared to analysts' expectations for 2% revenue growth and roughly flat EPS growth. That softer guidance was disappointing, but it wasn't surprising since many of TI's industry peers also recently reined in their near-term forecasts.

Image source: Getty Images.

Texas Instruments' stock dipped slightly after the report, and it remains down roughly 16% over the past 12 months. Should investors accumulate more shares of this resilient chipmaker while the bulls are looking the other way?

Understanding Texas Instruments' core business

TI mainly sells lower-end analog and embedded chips for the automotive, industrial, personal electronics, communications, and enterprise markets. These chips are cheaper to manufacture than higher-end chips like CPUs or GPUs, but they're just as essential because they support crucial wireless and power management features. TI manufactures its analog chips as its own plants, but it outsources the production of some of its embedded chips to third-party contract chipmakers.

Texas Instruments doesn't have much exposure to the PC market, which currently faces a painful post-pandemic slowdown. Instead, it generates most of its growth from the auto and industrial markets, which brought in 62% of its revenues last year.

TI's revenue rose less than 1% in 2020 as the COVID-19 pandemic disrupted those two markets. But in 2021, its revenue jumped 27% to $18.34 billion as the auto and industrial sectors recovered. Robust sales of new 5G smartphones amplified that growth. However, TI's revenue growth has been cooling off this year as it laps that post-pandemic recovery and grapples with intermittent COVID lockdowns in China, supply chain disruptions, and macro headwinds across the industrial sector.

But on the bright side, Texas Instruments remains well-insulated from the Biden Administration's latest export bans on advanced semiconductors to China, since it only sells lower-end chips. It should also qualify for subsidies and tax breaks from the recently passed CHIPS Act since it produces most of its own chips in the United States.

TI faces another cyclical slowdown

During the third quarter, Texas Instruments generated 76% of its revenue from analog chips, 16% from embedded chips, and the remaining 8% from other products. Here's how its two largest businesses fared over the past year.

Source: Texas Instruments. YOY = Year-over-year.

Texas Instruments' growth has remained stable, but its outlook for the fourth quarter indicates that investors should brace for a significant slowdown in 2023. Analysts currently expect Texas Instruments' revenue to rise 9% in 2022 and decline 7% in 2023, but those estimates might be lowered in light of its latest guidance.

Texas Instruments' gross and operating margins have held steady over the past year as it continued to transition from 200mm to 300mm wafers for the production of its analog chips. That upgrade reduces the costs of TI's unpackaged parts by roughly 40%. However, pouring more cash into its newer 300mm plants has also gradually reduced its free cash flow (FCF) margins.

Source: Texas Instruments. *Trailing 12 Months.

Yet Texas Instruments remains committed to returning more than 100% of its FCF to its investors. It returned $7.1 billion to its investors through buybacks and dividends over the past 12 months, which eclipsed its FCF of $5.9 billion during the same period. It also raised its dividend for the 19th straight year in September, which puts it one step closer to becoming a Dividend Aristocrat of the S&P 500, and it currently pays a forward yield of 3.1%. It has also reduced its number of outstanding shares by nearly 20% over the past decade.

The valuations and verdict

Analysts expect TI's earnings to rise 13% this year and then decline 13% in 2023 as the macroeconomic headwinds intensify. Based on those expectations, Texas Instruments' stock trades at 18 times forward earnings.

Texas Instruments might initially seem pricier than Intel and AMD, which trade at 9 and 12 times forward earnings, respectively. However, Intel and AMD are both struggling with the slowdown of the PC market and the export bans on advanced chips to China. TI's insulation from both headwinds arguably justifies its higher valuation, even if its growth will cool off as it faces other macroeconomic challenges in 2023.

I personally believe TI is worth buying at these levels, since it has weathered plenty of cyclical downturns before. However, investors should consider it a slow-growth dividend stock and maintain realistic expectations regarding its near-term returns.