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Political Status Quo Will Result in Stable Growth

ST

StjepanK

Not Invested

Equity Analyst and Writer

Published

October 23 2023

Updated

July 02 2024

Narratives are currently in beta

Announcement on 26 February, 2024

Organic Growth And Higher Margins Support Market Optimism

  • The company reported strong Q4 earnings in January, beating the upper end of guidance on revenue and operating margin.
  • Despite outstanding valuations around other companies that drive the AI sector, TSMC trades at a reasonable forward price-to-earnings ratio of 20x.
  • Management announced a 2nd fabrication facility in Japan, cementing regional dominance and further diversifying from Taiwan. Domestic giants Sony, Denso, and Toyota, as well as the Japanese government, will participate in this project.

Externalities Are Playing To TSMC's Strengths

  • AI and advanced technologies need chips above everything else, and TSMC is the clear leader, at least one step ahead of the competition. Deloitte and Nikkei predict strong AI growth with the AI semiconductor market surging to almost $120 billion by 2027, or 20% of the global semiconductor market, according to Statista.
  • Intel, a former market leader, is delaying plans for its $20 billion project featuring two chip factories, which will now be completed by late 2026 at the earliest.
  • Owing to continuous positive developments I'm keeping my bullish thesis unchanged.

Key Takeaways

  • A geopolitical status quo means TSMC can remain the market leader
  • It has a healthy balance sheet to invest in R&D and maintain its wide moat
  • Growing industry and large repeat customers will drive double-digit revenue growth
  • The stock has the potential to become a dividend aristocrat

Catalysts

Industry Catalysts

Continuous Demand and Reliance on Chips Will Support Revenue 

The computing power accessed through microchips is only increasing. It goes beyond smart devices and data centers, and in the 2020s, it is a vital part of the global economy. Arguably, chips are now present in any device with an on/off switch.

In the past, chips were a cyclical industry that revolved around computer and smartphone lifecycles. This effect is no longer the case. According to the historian Chris Miller, the global chip industry manufactured more transistors in 2021 than the combined quantity of all other goods produced by all other industries in all of human history.

TSMC Earnings and Revenue History 2023-2023 - Simply Wall St

 

The industry continues to grow, with an expected annual rate of 12.2% between 2023-2029, providing a favorable trend for companies operating in the sector.

 

AI Supports Both The Sales and Manufacturing Side of Things 

AI is engaged in a positive feedback loop with the chip industry. For a start, there is no AI without chips. However, AI allows the chip design to become more efficient and intelligent. Machine learning algorithms analyze vast datasets to generate optimized chip architectures.

Furthermore, AI-powered monitor systems smoothen the chip manufacturing processes, avoiding defects and potential issues. This results in higher productivity due to lower downtimes, higher product quality, and overall reduced costs.

 

Company Catalysts

Further R&D Will Sustain Competitive Advantage

TSMC's broad moat is so impressive that it even attracted Warren Buffett's attention. The company heavily invests in research and development to improve and produce chips with higher performance and lower power consumption than anyone else.

Most recently, the company launched the first dedicated research center in Hsinchu, Taiwan, aiming at developing the next 2-nanometer generation chips while keeping the technology within their borders.

 

Highly Dependent Customers Can Ensure Further Growth

TSMC served 532 customers in 2022; however, its top 10 customers accounted for over 2/3 of its revenues. While this would have been a significant risk if these companies were startups, the list is exactly the opposite of that. 

Industry leaders like Apple, Qualcomm, and NVIDIA are all highly dependent on TSMC for providing their cutting-edge hardware, and the management can rely on this fact as long as they remain a clear leader in this space.

 

A Strong Balance Sheet Can Fund Further Expansion

As evident from recent investments by companies like Samsung and Intel, semiconductor manufacturing requires significant capital.

With a rather healthy balance sheet, TSMC is more than ready to finance such endeavors. Although its debt has increased in the last 5 years, it still remains reasonably low and significantly below its cash & short-term investments.

 

Affordable Dividend Has Plenty of Space for Growth

TSMC is not famous for its dividend. However, the company accumulated some history, with 17 years of continuous payments. The dividend experienced steady growth and currently yields about 2.2%. 

While its current cash payout ratio is 107% of its trailing NT$290bn in FCF, the company has NT$1.49 trillion in cash, well more than 1 years worth of cash flows, so the dividend shouldn’t be at risk of being cut. Additionally I expect the free cash flows to recover over the next few years in line with earnings growth.

TSMC Earnings and Revenue Growth Forecasts - Simply Wall St

Assumptions

China-Taiwan Relations Will Continue As A Status Quo

I believe geopolitical relations in this region will continue as a status quo. I don't expect China to invade Taiwan without significant negative repercussions for a slim-chance scenario in which they acquire leading technologies.

 

TSMC Will Diversify And Grow Production Of Non-Leading Tech

While the main production remains in Taiwan, I believe the company will diversify and expand its overseas production in the US, Europe, and Japan. This move is a great hedge against geopolitical instability. However, due to a shortage of workers with critical expertise, I believe this effect won't be visible until at least 2026.

 

There Will Be No Stock Buybacks Or Stock Dilution

For over a decade, TSMC kept a stable number of shares at 5.186b. I expect this trend to continue without any changes.

Risks

Chinese Invasion Could Cause a Catastrophic Disruption

Taiwan's relationship with mainland China is a complicated one. Taiwan has had an independent government since 1949, but Beijing still considers it as a part of its territory.

In this situation, there are only 3 possible scenarios. The first one is the status quo, where everything remains as it is. The second one is an invasion, where Beijing takes control of TSMC, suffers initial backslash and sanctions, but eventually emerges as the next chipmaking powerhouse in the new multipolar chipmaking world.

The final scenario is an invasion where China fails to secure TSMC's hardware and know-how and suffers crippling sanctions on top of losing access to leading-edge chips.

While the status quo is the only good scenario here, an invasion of Taiwan is not out of the question due to escalating geopolitical conflicts. Such a scenario would have a profound impact, not only on TSMC but on the global economy as a whole.

 

Reliance on a Single Advanced Hardware Manufacturer is Problematic

Microchip production is impossible without lithography machines – produced by only a handful of companies worldwide. However, the most advanced extreme ultraviolet lithography (EUV) is limited to a single hardware manufacturer, ASML Holding (Nasdaq: ASML).

ASML, which started as a subsidiary of Philips, is the sole supplier of extremely advanced and expensive EUV systems that cost up to $200m a piece. Due to high complexity, the production is slow, with sales attributing approximately 140 systems in the past decade.

Thus, any disruption to ASML's operations outside of TSMC's power could be a significant issue to TSMC's business.

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Disclaimer

Simply Wall St analyst StjepanK holds no position in NYSE:TSM. Simply Wall St has no position in the company(s) mentioned. This narrative is general in nature and explores scenarios and estimates created by the author. These scenarios are not indicative of the company's future performance and are exploratory in the ideas they cover. The fair value estimate's are estimations only, and does not constitute a recommendation to buy or sell any stock, and they do not take account of your objectives, or your financial situation. Note that the author's analysis may not factor in the latest price-sensitive company announcements or qualitative material.
Fair Value

US$118.4

55.8% OVERVALUED

StjepanK's Fair Value

Future estimation in
PastFuture01t2t3t2014201720202023202420262029Revenue US$3.6tEarnings US$1.4t
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Current revenue growth rate

16.52%

Semiconductors revenue growth rate

0.96%

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