LLTC is a high quality dividend growth stock that will likely become a dividend aristocrat by 2019. Despite being a technology company, its business model has proven to be extremely durable and throws off substantial free cash flow. We believe these favorable characteristics will persist and continue to reward shareholders for years to come.

LLTC’s presence in industrial (40%+ of sales) and automotive (20%+) markets positions it to benefit over the next 10+ years as objects become smarter and more connected, demanding more of LLTC’s products. While the stock doesn’t appear to be a bargain today, it does appear to be a wonderful company trading at a reasonable price. Therefore, we added it to our Top 20 Dividend Stocks portfolio this past summer.

Business Overview

LLTC was founded in 1981 and manufacturers analog semiconductor chips. These chips are used in virtually every electronics product to monitor, amplify, condition, transform, or regulate signals found in the real world such as temperature, pressure, light, weight, and sound. They are also needed to provide voltage regulation and manage power usage.

Not surprisingly, LLTC’s products span a wide variety of applications, including automotive electronics, factory automation, process control, industrial instrumentation, networking products, medical devices, cellphones, computers, military systems, and more. By end market, LLTC has reduced its exposure to lower-margin, more volatile consumer and cell phone markets over the last decade and now derives 44% of sales from industrial, 20% from automotive, 18% from communications, 9% from computer, 6% from military, and 3% from consumer.

Some of the company’s principal product categories are amplifiers (augment the voltage of a device), data converters (change analog signals into digital signals), voltage regulators (control the voltage of a device at a specific level), interface circuits (act as intermediaries to transfer signals within electronic systems), and battery management (monitor the voltage on individual battery cells that are connected in series – electric and hybrid vehicles are a popular application).

Business Analysis

When LLTC went into business in 1981, the analog chip market was around $2 billion in size. By 2014, the market had grown to $44 billion, according to Texas Instruments. Unlike other semiconductor markets, the analog market is highly fragmented. Texas Instruments is the biggest player with 18% market share, and LLTC has less than 4% share.

In our opinion, the analog chip market is one of the few attractive areas within the technology hardware industry. Its pace of change is much slower because the chips that get designed into many applications must live for a long period of time. The chips used in industrial and automotive markets have long life cycles lasting for years compared with the rapid turnover in consumer devices such as smartphones. Importantly, the process technologies and assets used to produce these chips have long life spans, translating into higher returns on LLTC’s capital investments and R&D spending.

Price erosion and market obsolescence are also less significant risk factors within the analog chip market. Since most industry players (LLTC, Texas Instruments, Maxim Integrated, Analog Devices) are extremely well diversified by product and customer (e.g. LLTC sells to more than 15,000 OEM’s), they are more insulated from the rise or fall of a particular customer or market and can enjoy a longer tail of revenue.

Many of the products they sell also have long life cycles. When an analog company wins a slot in a customer’s product, the price is often fixed for the run of the product, creating better price stability than other chip markets that are more commoditized.

Within LLTC’s industrial (40%+ of sales) and automotive (20% of sales) end markets, many of the company’s products are mission-critical and must last for very long periods of time in harsh environments. Many analog products also contain high proprietary design content and are sole-sourced, with equivalent products only available from a small pool of other analog chip manufacturers. This further increases their stickiness and profitability.

High barriers to entry in the analog chip market add to its appeal. Designing analog chips demands an extremely specialized and creative skill set. Companies such as Texas Instruments have said that it takes 5-10+ years of experience beyond grad school to develop an analog engineer’s skills. LLTC has commented that its typical engineer has graduated from a top university with a Master’s degree in a chosen scientific field (generally electrical engineering) and has on average ten or more years of experience at LLTC. Acquiring, cultivating, and retaining this talent takes time and serves as an advantage because technical and creative analog designers are so hard to find.