Better Buy for Dividend Investors: NXP Semiconductors NV vs. Texas Instruments

By Markets

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Semiconductor giants NXP Semiconductors (NASDAQ: NXPI) and Texas Instruments (NASDAQ: TXN) have a lot in common. Both companies manufacture some of their chips in fully owned factories. Thanks to this strategy, they tend to sport some of the widest profit margins in the industry. And both are betting big on embedded chips for automotive computing and the Internet of Things.

Riddle me this, though: Which one of these chip stocks would be a better fit for an income investor's portfolio?

The answer is not quite as simple as you might think.

No contest!

At first glance, this comparison just isn't fair.

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Texas Instruments offers a 2.2% dividend yield today. The company spends 39% of its free cash flow on dividend checks, or 49% of its bottom-line earnings. Texas Instruments' dividend history started way back in 1993, and the payouts per year have been increased without fail in each of the last 12 years. This is the stuff that dividend champions are made of.

By contrast, NXP pays out...

Absolutely nothing.

Since spinning out from Philips (NYSE: PHG) in 2006 and then hitting the public markets in 2010, this company has never spent a nickel on dividends. Instead, the company prefers to deploy its spare cash in the form of early debt repayments and share buybacks.

So one company pays a dividend while the other one simply doesn't. Case closed!

Not so fast

A few months ago, NXP's management promised to start issuing dividend payments in 2017. The large debt retirement checks will continue to rule NXP's cash flows until the second quarter of next year, and that's where the dividends are supposed to come in.

How juicy will NXP's new dividend yield be? There's no way to really know yet, but we can make some educated guesses.

Let's say that NXP sets aside 25% of its free cash flows to fund the dividend policy. At the current run rate, that would work out to annual dividend expenses of roughly $275 million or $0.80 per share. At NXP's current share prices, that would amount to a 1% effective yield.

NXP could also match TI's 39% cash payout ratio, right out of the gate. In that case, an annual payout of $1.26 per share would give a 1.5% yield instead.

Going even further, let's suppose that NXP might inherit the dividend guidelines of its former parent company. Philips runs with a 52% cash payout ratio. Then we'd be looking at an annual payout of $1.66 per share and a 2% effective dividend yield.

Head to head

Not even the rosiest of my thought experiments results in an NXP dividend that can match Texas Instruments' 2.2% yield. On top of that, NXP has no dividend history to speak of and all of these projections are only educated guesses. Chances are that NXP will start from a cash payout ratio below even the 25% baseline we looked at here.

There's nothing terribly wrong with starting out slow. NXP has other cash-spending priorities to worry about, such as even further debt reductions and a strong commitment to the company's R&D lifeblood. It's just that it'll take a while before NXP's dividend policy can stand shoulder to shoulder with grandpa Philips or rival Texas Instruments.

The choice for dividend investors is clear (but not quite as blindingly obvious as you might have thought): Texas Instruments wins by a knockout in the third round.

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Anders Bylund has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.