Founded in 1930, Texas Instruments (TXN) is a leading, global analog and embedded semiconductor chip designer and manufacturer. Analog chips convert physical phenomena such as temperature, pressure, and light into digital signals and embedded chips process those signals. Both types of chips are used in just about every “smart” device including computers, cell phones, automobiles, and industrial systems.
The business case for an investment in the company is driven by its shift in analog chip manufacturing, its focus on automotive and industrial end markets, and new technology trends.
As a manufacturing company, TXN realizes significant economies of scale. The marginal cost per chip decreases as manufacturing utilization increases. The company is currently converting its analog chip manufacturing from processing 200 mm wafers to 300 mm wafers. This increases the production throughout by 50% due to the larger wafer size and reduces the cost per chip by approximately 40%. The company is currently utilizing half this capacity. By combining the shift to 300 mm wafer manufacturing with increasing utilization, we expect margins to expand over the long term. TXN’s competitors still typically manufacture using the more expensive 200 mm wafer process due to the capital intensity to shift to the larger wafer size, which builds on TXN’s significant competitive advantage.
We also support the company’s shift to the automotive and industrial markets. Combined, these segments account for 54% of sales compared to 42% of sales in 2013. Semiconductor demand for these markets is typically more stable than other markets like consumer electronics because automotive product line and industrial systems tend to have much longer product life cycles. These systems are mostly custom designed, and once TXN’s semiconductors are designed into the systems, they cannot be easily substituted.
We expect TXN will also benefit from future technology trends such as increasing semiconductor content in “smart” products, autonomous vehicles, the Internet of Things (IoT), and 5G wireless systems. As a result, we believe TXN is well positioned to capitalize on these significant technology trends.
We believe Texas Instruments provides important ‘Jensen Quality Growth’ characteristics including competitive advantages, a consistently high return on equity, and robust free cash flow generation. Importantly, our valuation metrics indicate the stock price does not fully value the strengths of the company’s business and its growth profitability opportunities, even with relatively modest assumptions. We expect the disconnect between the company’s business fundamentals and stock price valuation to normalize as the company demonstrates the ability to further enhance its margins and capitalize on new technology trends.
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