If you like, dividends, dividend growth, and the prospects of technological innovation, analog and embedded semiconductor stocks are a great place to look.
Analog and embedded chip companies are generally capital-light and less volatile than other types of semiconductors. Capital-light, because trailing-edge manufacturing doesn't have the high capital requirements of leading-edge logic and memory plants. Less volatile, as analog and embedded chips go into a wide variety of electronic equipment.
Beyond diversification, analog and embedded chips in large, complex machines such as planes, automobiles, and factory equipment tend to have long-lived, dependable revenue streams. This is because of the complexity, temperature and pressure requirements, and long development cycles of highly sophisticated equipment.
Not only are these profits streams dependable, but they're also high-growth. According to McKinsey, automobile and industrial semiconductors will be the two highest-growth subsectors of the semiconductor industry this decade, projected to grow 13% and 9% on an annualized basis through 2030, respectively.
Two leaders in the embedded and analog chip industry are Texas Instruments (TXN 0.25%) and Microchip Technology (MCHP 1.69%). But which is the better buy today?
Microchip is growing the fastest
Microchip is the faster-growing of the two companies, and it's not close. This may be somewhat due to size, as Texas Instruments hauled in a massive $20 billion in revenue in 2022, while Microchip brought in just over $8 billion over the past 12 months, or about 40% of TI's scale. So, it's easier for smaller companies to grow faster.
Still, the most recent quarter shows Microchip making even bigger gains. Last quarter, Microchip grew sales 23.4% over the prior year, while Texas Instruments showed a 3% decline. While different mixes of chips can lead to quarterly fluctuations, Microchip has also excelled over the past year or so. In the nine months ended in December, Microchip grew revenue 24.7% over the prior year, while Texas Instruments grew revenue by just 9.2% in 2022.
Not only that, but Texas Instruments has guided for a sequential decline in revenue in the current quarter, while Microchip again guided for a sequential increase in both the March and upcoming June quarters.
Whether due to product mix or execution, it appears Microchip's offerings are still in high demand even in a weaker economic environment. Not only that, but over the longer term, Microchip has also generally grown at a higher rate:
TXN Revenue (Quarterly YoY Growth) data by YCharts
While the revenue picture looks like a no-brainer pick for Microchip, there is a catch to all of this growth.
Texas Instruments has the better yield and balance sheet
While Microchip appears to be out-executing in 2022 and 2023, its past growth has come from some rather large acquisitions. Most notably, Microchip acquired Atmel for $3.56 billion in 2016, and then Microsemi for an enterprise value of $10.15 billion in 2018. Both acquisitions were very large compared with Microchip's size at those times.
While those acquisitions appear highly accretive and beneficial for Microchip, they did load Microchip's balance sheet with debt. As you can see, Microchip still has a fairly sizable $6.3 billion in net debt, while Texas Instruments has a small net cash position and lots of liquidity.
TXN Net Total Long Term Debt (Quarterly) data by YCharts
While Microchip is paying out a dividend and repurchasing some stock, it has been devoting a lot of its free cash flow to servicing that debt since 2019. On the other hand, Texas Instruments generally pays out all of its free cash flow to shareholders in dividends and share repurchases.
That's why Texas Instruments currently has a higher dividend yield of 2.7% versus Microchip's 1.7% yield, and it may also explain Texas Instruments' higher valuation in spite of lower growth. Currently, Texas Instruments trades around 19 times earnings, but Microchip trades at just 14.4 times estimated non-GAAP earnings for its fiscal year ending in March.
Still, even yield-seekers may not want to dismiss Microchip, as it is paying down debt rapidly and raising its dividend at a faster pace than TI. On its recent earnings release, Microchip's management announced a 9.2% sequential increase and 41.5% year-over-year increase in its dividend. Combined with some repurchases thrown in for good measure, Microchip plans to return 62.5% of free cash flow in dividends and repurchases next quarter, with the rest going to debt pay-down.
With Microchip closing in on its leverage targets after four years of paying down debt, management plans to steadily increase the portion of cash flow going to shareholders by five percentage points every quarter, until 100% of free cash flow is paid to shareholders about eight quarters from now.
Meanwhile, Texas Instruments raised its dividend by 8% in 2022, its 19th consecutive year. Yet while TI has been a rock-solid dividend-grower, Microchip looks to be closing the gap fast.
Diverging strategies on manufacturing will be important through 2030
While it appears most recent results favor Microchip, investors should also be aware of a key strategic difference between the two, having to do with internal manufacturing strategies and capabilities.
At its recent capital management presentation, Texas Instruments announced a multiyear acceleration in spending to massively increase its internal manufacturing capacity. TI now plans to ratchet up capital expenditures to $5 billion per year between 2023 and 2026 -- a much higher amount than over the past decade -- and then keep capital expenditures between 10% and 15% of revenue thereafter -- a higher percentage than in the 2012-2020 time period.
That money is going to six different brand-new fabs that can produce chips on 300mm wafers, a technology that offers significantly lower costs per chip than the 200mm wafers used by most competitors. In addition, TI is likely to get some help from CHIPS Act subsidies of about $1 billion per year, offsetting the impact.
Despite the current softness, TI's management said recent conversations with customers have only increased its confidence in its long-term growth prospects. The current build-out will support $45 billion in revenue by 2030, up from just $20 billion last year.
Image source: Texas Instrument Capital Management Day presentation.
Meanwhile, Microchip actually just announced it won't be building its own internal 300mm capacity, as it had hinted it might. Microchip has some internal capacity but outsources more of its manufacturing than TI does. Instead, management believes it can achieve better returns on capital by partnering with third-party foundries to satisfy its 300mm demand over the next several years.
This is where the choice gets complicated; while Texas Instruments' build-out will likely pressure margins and free cash flow in the near term, the large spending program could provide Texas Instruments with a low-cost manufacturing advantage and valuable asset over the longer term.
A tough choice -- why not own both?
While both Microchip and Texas Instruments sell similar types of products to similar applications, both are at a different place strategically. Microchip has invested heavily in acquisitions over the past decade and is now harvesting the benefits through growth, synergies, and expanding margins and cash flow.
Meanwhile, Texas Instruments, after generating tons of cash flow over the past decade, is now embarking on its own investment cycle with its large internal manufacturing investments. That could build a longer-term manufacturing advantage, and it's also bullish that TI is seeing that much long-term growth potential.
Still, while I own Texas Instruments, I would likely add more Microchip with new investment dollars if I had to choose. The ramped investments could pressure TI's stock in the near term, and given Microchip's stellar recent execution, it's probably a good idea to own both of these two all-star chip stocks in any dividend growth portfolio.
