As semiconductor companies have been predicting for some time now, the market is currently in the middle of a nasty slump. Even longtime chipmaker and top dividend stock Texas Instruments (TXN -2.44%) is getting hit. Revenue and earnings per share fell a respective 11% and 21% year over year in Q1 2023, and things are expected to get worse for at least one more quarter before starting to rebound in the second half of 2023.
Now nearly a century old, the oft-vaunted TI has been through its fair share of semiconductor market pain. But we're entering uncharted waters for this old manufacturing giant, a period where elevated spending could put a serious damper on Texas Instruments' favored financial metric: free cash flow per share. Is it time to sell this dividend stock?
What happened to the cash?
Although TI is a cyclical business, as is all manufacturing, dividend growth investors love the company because of its robust cash-generation superpower. Indeed, this industrialist has been churning out cash and doling all of it out via a dividend and stock buybacks for many years. It has been a potent combo that has helped Texas Instruments stock beat the market.
Data by YCharts.
But take note of that big drop-off in free cash flow (FCF). Indeed, FCF was a paltry $178 million in Q1 2023, an FCF profit margin of just 4% -- compared to an FCF profit margin of 23% over the last trailing-12-month period, and a whopping 34% FCF margin during the 12-month period ending in Q1 2022. Ouch!
This is obviously more than just a temporary reduction in revenue as TI and its semiconductor peers help their customers work through excess inventory and manage expected economic headwinds in 2023. What in the world happened?
To grow, you've gotta spend money
TI has enjoyed years of steady growth from focusing its attention on older tech components that remain in steady demand -- in particular from the industrial and automotive sectors. But suddenly, after ignoring tech trends of the last couple decades, the industrial sector of the economy is in need of more chips -- a lot more of them.
The problem is, booming demand can't be met with the existing chipmaking facilities (which, at least in part, helped contribute to the chip shortage in late 2020 through 2022). If Texas Instruments wants to capture this new market for industrial applications -- including from electric vehicles and the electrification of the power grid -- it's going to need to build new chip fabs (the facilities that make chips) and expand existing ones.
Fabs cost a lot of money, though, and legislation like the $52 billion U.S. CHIPS Act isn't designed to cover these costs. Rather, the U.S. CHIPS Act was designed to jump-start interest in building these facilities. And lots of TI peers are interested in expanding, too.
Thus, Texas Instruments' capital expenditures (or capex, which gets subtracted from operating income to calculate free cash flow) is going through the roof. Capex is expected to average $5 billion over the next four years. TI's CFO Rafael Lizardi emphasized it will be higher some years and lower in others, and will be partially offset by CHIPS Act funding (a currently unknown, but likely small, amount). But, and this is a big but, $5 billion a year in capex is a massive increase from what investors have grown accustomed to.
Data by YCharts.
So, sell Texas Instruments, right?
All of this is to say TI's oft-cited growth metric, free cash flow per share, could be going on a long hiatus for the next few years. It's necessary spending if the old chipmaking giant wants to stay current with the times and capture the boom in electrification, industrial automation, and such. But suffice to say things could get far bumpier than they were over the last decade of sustained FCF growth, thanks to historically low capex spending from TI.
The good news is TI is in great shape, with a balance sheet featuring over $9.5 billion in cash and short-term investments and debt with very low interest rates of $10.1 billion. Nevertheless, new risks are emerging for Texas Instruments that investors in this top chip company haven't had to face in a long time.
I certainly don't think it's time to sell TI. Disruption to business models help forge new resiliency, and TI can certainly come out on top in four years' time. But now might be a good time to hedge your semiconductor portfolio, perhaps with a company like Applied Materials that provides fab equipment and thus gobbles up Texas Instruments' elevated capex spending. If you like dividend growth, fab equipment companies are great stocks to own, too.
