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Better Buy: NXP Semiconductors vs. Texas Instruments

John Ballard, The Motley Fool

Last year, semiconductor sales hit an all-time high, climbing 13.7% to $468.8 billion across the industry. The computerization of cars, factory automation, and the Internet of Things (IoT), among other uses, have caused a massive secular tailwind for leading chip suppliers in recent years.

This year is going to be a slower one for the industry, but at some point, the above trends will take over again, and sales growth will resume. NXP Semiconductor (NASDAQ: NXPI) and Texas Instruments (NASDAQ: TXN) are two of the largest chip suppliers for car companies and industrial applications. Investors can't go wrong with either stock for the long haul, but today we're going to narrow the choice down to the single best stock to buy.

A car with headlights turned on driving along a path overlayed with bright computer circuit board lines.

IMAGE SOURCE: GETTY IMAGES.

What do these companies do?

NXP Semiconductor supplies a wide range of chip products across the automotive, industrial, and IoT sectors, as well as security technology for the banking industry. The company has more than 25,000 customers, ranging from top auto suppliers like Autoliv, Bosch, and Delphi Technologies to leading consumer brands including Amazon.com and Apple.

NXP has been in business for more than 50 years. In 2018, the company generated $9.4 billion in revenue and was either No. 1 or No. 2 in market share across most product categories.

In addition to supplying chips for cars and industrial companies, Texas Instruments makes chips for a range of consumer products like electric toothbrushes and calculators, as well as for Apple's iPhone. The company is able to sell chips at competitive prices due to its low-cost manufacturing process, which it has fine-tuned for nearly a century.

NXP and TI butt heads in the automotive market. Auto revenue makes up 48% of NXP's top line, while Texas Instruments generates the majority of its revenue from the combination of products sold to the auto and industrial markets. These markets are very attractive to these companies, as product life cycles are long, customer relationships are tight, and margins are very high.

Last year, NXP and TI produced operating margins of 28.8% and 42.5%, respectively, which speaks volumes about both companies' competitive moats. These chip suppliers have spent decades streamlining their manufacturing processes and building relationships with customers that are nearly impossible to duplicate.

Which company is growing faster?

After a record year for the semiconductor industry, it's understandable that 2019 will be a slower year of growth. Excluding economic issues, chip companies are also dealing with tough year-over-year growth comparisons.

In 2018, NXP increased sales by 1.6%. Over the last five years, the company has increased revenue and free cash flow by 83% and 349%, respectively, driven partly by acquisitions. However, macro trends caught up with the company in the fourth quarter of last year, with sales falling 2% year over year. The company blamed the sales drop on weakness in the automotive and industrial markets in China, which also disrupted sales growth for Texas Instruments.

Texas Instruments sales increased by 5.5% last year. Revenue and free cash flow climbed 26% and 89%, respectively, over the last five years. But as expected, the company experienced weak demand in the first quarter, causing revenue to fall 5% year over year, while earnings per share dropped 7%.

Both companies anticipate weaker revenue in the short term, but NXP expects a turnaround in demand starting in the second quarter. For the first quarter, NXP expects revenue to be down 8% year over year at the midpoint of guidance.

Currently, analysts expect NXP to report a decline in revenue of 5% to $8.94 billion for 2019. On the other side, analysts expect TI to report full-year revenue of $14.92 billion, representing a decline of 5.5% year over year.

Neither company has an advantage on growth right now, but NXP has clearly been a better growth company over the last five years. Looking beyond 2019, analysts expect NXP to grow earnings about 11% per year, while they anticipate TI growing earnings 8% per year.

One reason NXP may grow somewhat faster is that its radio frequency (RF) technology positions the chip firm to benefit from the tailwinds of the 5G rollout and IoT adoption. This plays to the strengths of NXP, as the company is the No. 1 supplier of RF power.

Advantage: NXP Semiconductors.

Financial fortitude

The chip industry goes through cycles of rising demand followed by softness depending on what the economy is doing. A strong financial position can help a company weather the storm and allow for the potential for accretive acquisitions and dividend increases to create shareholder returns.

Here's a comparison of key financial metrics for NXP and TI:

Metric NXP Semiconductor Texas Instruments
Cash $2.789 billion $4.233 billion
Debt $7.354 billion $5.068 billion
Revenue (TTM) $9.407 billion $15.78 billion
Operating margin (TTM) 28.38% 44.56%
Free cash flow (TTM) $3.708 billion $6.058 billion

Data source: YCharts. TTM = Trailing 12 months.

Overall, Texas Instruments has a much stronger financial position than NXP. TI is a larger company based on revenue, and it also has less debt and generates a higher operating margin.

Advantage: Texas Instruments.

Valuation

Here's how both companies stack up on valuation:

Metric NXP Semiconductor Texas Instruments
Trailing PE 14.65 20.55
Forward PE 12.96 22.4
PEG ratio 1.16 2.79
Payout ratio 14% 47%
Dividend yield 1.01% 2.28%

Data source: Yahoo Finance! PE = Price-to-earnings ratio. PEG = Price-to-earnings-growth.

NXP's forward P/E of 12.96 looks really cheap, given that analysts expect the company to grow earnings about 11% annually. TI has a higher dividend yield, but that's due to a higher payout ratio. Overall, NXP is by far the better value.

Advantage: NXP Semiconductor.

NXP is the better buy

Both NXP and TI should be solid investments, given the increasing computerization of just about everything, especially the increasing chip content in cars.

However, NXP is the better buy because it has the edge on valuation and growth expectations.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. John Ballard owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Apple. The Motley Fool owns shares of Texas Instruments and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends NXP Semiconductors. The Motley Fool has a disclosure policy.