2023-08-14 12:26:32 ET
Summary
- Taiwan Semiconductor Manufacturing Company Limited benefits from the mass adoption of AI, with its AI chip segment expected to grow at 50% CAGR over the next several years.
- The company controls nearly 60% of the chip foundry market, with its competitors having a combined market share of 41%.
- Taiwan Semiconductor stock is relatively cheap compared to other AI stocks, trading at a mere 15 times earnings, and has the potential for strong growth in the future.
Taiwan Semiconductor Manufacturing Company Limited ( TSM , "TSMC") is a rare breed: an artificial intelligence, or AI, play that also has value characteristics. As Nvidia Corporation’s ( NVDA ) main manufacturer, it gains from the big increase in AI chip sales that company is experiencing .
TSM, like Nvidia, benefits from the mass adoption of AI taking place this year. However, it is not benefitting from it to quite the same extent that NVDA has. TSM delivered negative growth in revenue and earnings in its most recent quarter. It did see growth in its AI chip segment, which it expects to grow at 50% CAGR over the next several years. But that segment was only 6% of the overall business to begin with, so its extreme growth will not translate to extreme growth for the whole firm. At least, not in the coming year.
Over the longer term, AI chips could ramp up TSMC’s whole firm revenue growth substantially. If you start with one segment being 6% of the whole firm, and it grows 50% while the rest grows at 0%, you have 3% growth in the firm. If the category grows 50% again after that, with no growth in the rest of the firm, then the whole firm grows 4.36%. After five years of this, the category that was just 6% of a larger firm, is now about a third (~33%), and a major growth driver for the whole enterprise. So, if TSM’s projected growth in AI chips can maintain for five years, then it will eventually overcome the weakness in the rest of the business.
That alone is one reason to be excited about TSM right now. There’s also the fact that the non-AI part of the business, which is experiencing negative growth currently, probably won’t decline forever. Computer chip making is a cyclical industry , and computer/smartphone sales are declining right now. Some have described the economic condition in 2022 as a “ tech recession ,” in which tech sales flatlined or declined, while other industries did well. The most recent crop of big tech earnings releases showed a moderate increase in earnings, but smartphone sales remained weak at Apple ( AAPL ) and Google (GOOG). In other words, we are in a predictable “down” phase of the hardware industry, one that we will likely bounce back from in the future.
So, not only is TSM forecasting 50% CAGR growth in its AI chip segment, it should return to growth in the other parts of the business as well. Therefore, we can expect strong overall growth in TSM’s business when the next cycle begins. Apple is releasing the next iPhone in September and bringing the Vision Pro to stores in January, so we could see TSM’s fortunes begin to turn around as soon as this year’s fourth quarter. It’s for this reason that I think TSM stock is a buy today. In the ensuing paragraphs, I’ll elaborate on my thesis about AI, then move on to a more general analysis of the company.
TSMC’s Nvidia Opportunity
The AI opportunity in front of TSM right now is massive. Nvidia has said that it will do $11 billion worth of sales in the second quarter, and a full $4 billion of that (the difference between the prior guidance and the current guidance) will be from AI chips. TSMC, of course, does not get as big a benefit from AI as Nvidia does, since NVDA’s entire AI product line makes up just 6% of TSMC’s manufacturing business. That percentage will likely grow over time, so its relatively small contribution today will be a large contribution tomorrow.
There are several other chip foundries apart from TSMC. The most important are:
All of these are big companies in their own right. However, their portion of the foundry pie is miniscule compared to TSMC’s. According to CounterPoint Research , the semi industry market shares break down as so:
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Taiwan Semiconductor - 59%.
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Samsung - 13%.
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GlobalFoundries - 7%.
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UMC - 6%.
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SMIC - 5%.
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Others - 10%.
As you can see, TSMC controls nearly 60% of the market, the runner ups have a mere 41% combined.
Another company is worth mentioning here: Intel Corporation (INTC). Its share was not even big enough to merit an individual mention on CounterPoint’s list, but its foundry is growing very rapidly. In its most recent quarter, Intel’s Foundry did $232 million in revenue, up 307% year-over-year. That’s a far cry from TSMC’s $15.6 billion in Q2 revenue, although Intel’s foundry growth was much better than TSMC’s was in Q2.
At this point, though, I wouldn’t consider Intel a serious threat: doing just 1.4% of TSMC’s revenue, it has a long way to climb to even get into the latter company’s ballpark. Also, foundry services are very capital intensive, involving $400 million EUV lithography machines , massive production floors, and other PP&E. For this reason, Intel will have to go through a costly procurement and setup process before it can approach TSMC’s scale. So, TSMC will likely be getting the bulk of A100 and H100 orders from NVIDIA for the foreseeable future.
Recent Earnings
Having Explored TSMC’s AI opportunity, we can now turn to more "general" things about the company.
First up: the most recent earnings release.
In the most recent quarter , TSMC delivered:
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$15.7 billion in revenue, down 13.7%.
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$5.93 billion in net income, down 23%.
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$1.71 in earnings per share (“EPS”), down 23%.
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A 54.1% gross margin.
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A 42% operating margin.
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A 37.8% net margin.
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Guidance for $16.5 billion to $17.5 billion in revenue in Q3.
The release technically beat expectations , in that the reported earnings and revenue came in higher than expected. However, the guidance – which implied continued negative revenue growth lasting into Q3 – was less than what Wall Street hoped for. TSM stock sold off after the release came out.
Certainly, some adjustment was required after TSM put out its downbeat guidance. However, the stock is already down some 4% post-earnings. The effect of lower revenue is likely priced in.
Valuation
Last but not least, we can get into TSMC’s valuation. At today’s prices, TSM stock trades at :
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15 times adjusted earnings.
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14.3 times GAAP earnings.
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6.21 times sales.
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4.34 times book value.
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9.5 times operating cash flow.
It’s a relatively modest valuation. For comparison, the NASDAQ 100-Index (NDX) is currently at 30 times earnings , and the S&P 500 (SP500) at 20. TSM is relatively cheap compared to its sector, and the U.S. stock market.
We can also look at TSMC’s valuation in terms of discounted cash flows. In the trailing 12-month period, TSM had $6.15 in earnings per share . Discounted at the 10-year treasury yield ( 4.2% , US10Y), that’s worth $146.42. If you add a 4% risk premium, it’s worth $75. The average of these two estimates is $110, suggesting a decent amount of upside at varying levels of risk.
The Bottom Line
The bottom line on TSMC is this:
It’s one of the most reasonably valued AI stocks on earth right now. Trading at a mere 15 times earnings, it is far cheaper than most of the AI names out there. Not only that, but it has a real shot at making money off AI. With AI server costs being massive , it’s not clear how AI vendors will turn a profit. TSMC, as a chip manufacturer, is in a classic “selling shovels in a gold rush” situation. It’s not hard to see TSM returning to strong growth in the years ahead; if it does so, then its current valuation will end up looking dirt cheap with the benefit of hindsight.
Editor’s Note : This article was submitted as part of Seeking Alpha’s Best AI Ideas investment competition , which runs through August 15. With cash prizes, this competition -- open to all contributors -- is one you don’t want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!
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Taiwan Semiconductor: A Rare Undervalued AI Idea