Shares of NXP Semiconductors (NASDAQ:NXPI) have climbed nearly 150% over the past five years on robust demand for its multi-purpose semiconductors, chips for connected cars, and NFC chips for mobile devices. Last December, NXP closed its $12 billion acquisition of rival Freescale, which is expected to boost annual sales 57% to $9.6 billion this year.
Analysts expect NXP's earnings to grow 25% annually over the next five years, which gives it a very low 5-year PEG ratio of 0.5. Increased demand for connected cars should also benefit NXP, since buying Freescale should boost the weight of automotive sales on its top line from 26% in the fourth quarter to 36% in the first quarter.
However, the deal has several drawbacks. To satisfy antitrust regulators, NXP sold its RF unit to a Chinese company for $1.8 billion last year. Numerous redundancies between NXP and Freescale also must be addressed and eliminated. As a result, NXP's forecast for the first quarter is actually 17% lower than the combined sales of both companies a year earlier. NXP doesn't pay a dividend, but it spent $474 million on buybacks in 2015. However, it hasn't revealed how its increased debt load from the Freescale deal will impact those buybacks.
Therefore, NXP looks like a decent investment, but I think investors looking for other solid semiconductor plays can also consider two other chipmakers -- Texas Instruments (NASDAQ:TXN) and Broadcom Limited (NASDAQ:AVGO).
At first glance, Texas Instruments' numbers look weaker than NXP's. Annual sales are expected to fall 1.6% this year to $12.8 billion. Earnings are only expected to improve 10% annually over the next five years, giving the stock a fairly high PEG ratio of 1.9. 11% of TI's 2015 sales came from Apple (NASDAQ:AAPL), which exposes it to peaking iPhone sales. Another 13% came from communications equipment, which fell 20% last year due to telcos delaying infrastructure upgrades in favor of ecosystem growth.
However, TI's free cash flow has grown at a compound annual growth rate of 7% since 2004, thanks to its shift toward higher-margin analog and embedded chips. Its recent transition from 200mm to 300mm wafers also reduced the production cost of its chips by 40%, boosting its gross margin to a record high of 58.5% last quarter. Like NXP, TI expects chips for connected cars, which generated 15% of its 2015 sales, to drive sales over the next few years.
TI, which previously pledged to return 100% of its FCF to shareholders as buybacks and dividends, is a more shareholder friendly company than NXP. The company has reduced its share count by 41% since 2004, hiked its dividend 12 years in a row, and currently pays a forward annual yield of 2.8%. Therefore, investors interested in a conservative income stock should take a closer look at TI.
Last year, chipmaker Avago agreed to acquire Broadcom for $37 billion in one of the tech industry's biggest deals. That deal closed in February, and the new company was renamed Broadcom Limited. Broadcom expects the deal to generate $750 million in annual cost synergies over the next 18 months, and become "immediately accretive" to its non-GAAP EPS and free cash flow.
Analysts expect the merger to boost the Broadcom's revenues 91% this year and another 23% in 2017. Earnings are expected to rise 18% annually over the next five years, which gives the stock a fairly cheap PEG ratio of 0.8. The combined company expects to report non-GAAP gross margin of 59% for fiscal 2016 -- down slightly from 61% in 2015.
Like TI, Broadcom is a major Apple supplier. Prior to the merger, Apple orders accounted for "more than 10%" of Avago's quarterly sales and 14% of Broadcom's 2014 revenue. Last quarter (which only includes Avago's stand-alone sales), wireless communications revenue fell 13% annually due to sluggish iPhone sales. However, Broadcom posted double-digit growth in both enterprise storage and wireless infrastructure, where demand for its optical components has bucked the telco slowdown and remained strong.
On the surface, Broadcom and NXP's mergers have several similarities -- they both strengthen their economies of scale, broaden their portfolio, and widen their moats. However, Broadcom currently pays a forward dividend yield of 1.2%, and previously hiked that payout for six consecutive years. As an income investor, that makes the "new" Broadcom a slightly more appealing choice than NXP.
But don't underestimate NXP
I personally prefer stability and dividends, so TI and Broadcom are more appealing to me. But for investors seeking out cheaper valuations and don't mind the higher volatility and lack of dividends, NXP is still a solid choice. As always, investors should do their homework to see which of these three chip stocks is best suited for their investing goals.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple and NXP Semiconductors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.