Investment Thesis

Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) has a 59% market share and is the world’s largest semiconductor foundry. TSMC holds key partnerships with Apple Inc. (AAPL) and NVIDIA Corporation (NVDA), and yet the company is only trading at a little over $120. Despite recent financial challenges and geopolitical concerns, TSMC has taken great strides to overcome these hurdles and set itself up for long-term success. The company has leveraged its large-scale manufacturing capabilities and critical partnerships to become a key player in the geopolitical landscape and the emerging AI market. For investors looking for a semiconductor stock with a high probability of long-term growth, TSMC is a safe bet.

Introduction

With an ever-expanding global footprint, a uniquely innovative business model, and key strategic partnerships, there’s a reason The New York Times called Taiwan Semiconductor Manufacturing Company the “most important company in the world”. This Taiwan-based semiconductor manufacturer produces about 90% of the world’s most advanced chips which are key components to consumer electronics, telecommunications, and computing devices. The company specializes in the production of integrated circuits and offers a range of semiconductor services, including the design and manufacture of transistors, chips, and other microelectronics. TSMC’s large-scale manufacturing capabilities have given the company a reputation for high-quality production and efficiency. Because of this, TSMC’s services have become integral to many major technology companies, including Apple, Nvidia, AMD, Qualcomm, and Broadcom. As a foundry, TSMC focuses more on the manufacturing of chips rather than the design, offering their expertise and manufacturing capabilities to companies that design their own semiconductors. This business model has positioned TSMC as indispensable in the global tech world, making it an essential part of the ongoing advancements in electronics, digital technologies, and artificial intelligence.

Navigating Financial Challenges With Strategic Maneuvers

Although 2023 presented financial challenges for TSMC, the company experienced several positive financial developments that provided a strong foundation for growth in 2024 and the years to follow. On the surface, things trended downward for Taiwan Semiconductor, with the company’s revenue decreasing 8.7% to $69 billion in U.S. dollar terms and full-year EPS declining 17.5%. This might seem alarming at first, but we need to consider TSMC in the context of the greater semiconductor industry, which faced a particularly challenging year in 2023.

High inflation and interest rates paired with weakening global macroeconomic conditions led the global semiconductor industry to decline about 2% last year. Periodic fluctuations in the semiconductor industry are very common due to the sector’s highly cyclical nature; it is largely beholden to the sales of smartphones, GPUs, and other tech products that use chips. Because of this, investors should focus less on the decline that TSMC experienced and pay more attention to their resilience in response to this temporary downturn. TSMC’s earnings per share hit $1.44, surpassing expectations, and the company experienced an impressive 27% quarter-over-quarter increase in smartphone semiconductor sales.

Additionally, TSMC’s management focused on positioning the company to address the increasing demands of generative AI applications. A lot of money and effort was dedicated to ramping up the production of 3-nanometer technology, which already contributes significantly to TSMC’s revenue. Advancing their products through R&D investments in 3-nanometer and 2-nanometer technology is critical, as it places TSMC at the forefront of semiconductor innovation, catering to the growing demand for more efficient and powerful chips. The continued development and expansion of TSMC’s advanced technologies should drive future growth and maintain its competitive edge in emerging markets like AI.

Increasing technological development will most certainly extend TSMC’s leadership in the semiconductor space in the long run. However, this endeavor is not without its faults. The company’s gross margin slightly decreased to 54.4% and its operating margin also declined by 6.9 percentage points. Both these developments were due largely to the cost-intensive ramp-up of the 3-nanometer technology. These factors suggest that while TSMC is investing heavily in future growth and technological leadership, these investments come with short-term financial implications.

What I found most optimistic about TSMC’s financials is the unwavering confidence of the company’s management. Despite global economic uncertainties, Director of Investor Relations Jeff Su and CEO C.C. Wei both spoke extremely positively about the future of Taiwan Semiconductor, particularly in relation to the AI boom. Their forward-looking financial objectives are related to organic growth, financial flexibility, and long-term profitability, and they emphasized how well-suited the company is to capture a major portion of the tech market in terms of semiconductor components in AI.

For example, TSMC has met with Nvidia in Taipei to discuss the future of AI Chips and has been in talks with OpenAI’s Sam Altman for a major project aimed at boosting chip-making capacity for AI. By strategically aligning with key AI initiatives and market leaders, TSMC’s management has placed the company in a prime spot to profit from the AI boom. So I feel, when considered holistically, TSMC’s current financial position is pointing towards a huge turnaround in 2024.

TSMC’s Expansion Into Key Geopolitical Regions

Last year, Warren Buffett called Taiwan Semiconductor “one of the best-managed and important companies in the world,” but he sold his stake in the company due to concerns about the company’s location. The company being primarily based in Taiwan does pose concerns due to tensions with China, but TSMC has made some key strategic maneuvers in the past weeks to cement its position in the global supply chain and mitigate these geopolitical risks.

In an effort to diversify its advanced chip manufacturing and meet increased customer demand, TSMC is investing tens of billions in the United States and Japan to build new fabs in Arizona and the Japanese island of Kyushu. While these initiatives will most certainly scale production for Taiwan Semiconductor, they more so support my bullish stance because they signify TSMC’s immense global importance in an increasingly tense geopolitical environment.

The U.S. has chosen to back TSMC financially as part of the $53 billion CHIPS Act, but this support isn’t merely monetary; it’s a strategic alignment to reduce U.S. dependence on foreign chip manufacturing amidst rising tensions with China. TSMC is now positioned as a central player and valuable asset in a tech rivalry between global superpowers, which should drastically enhance the company’s global standing and lead the chipmaker toward major profits in new markets down the road.

Similarly, the Tokyo government is providing billions in subsidies to assist TSMC’s $20 billion foray into Japan. Taiwan Semiconductor’s first Japanese plant is set to start operations in 2024, and they will also begin construction on a second fab this year that should be complete by 2027. This expansion, like the American expansion, is crucial to TSMC’s geopolitical interests and its sector dominance. Japan’s historical prowess in technology makes it an ideal partner for TSMC, potentially leading to innovative collaborations and a stronger foothold in Asian markets. Not only that, but Japan’s desire to be a leading chip manufacturer on the world stage should help TSMC strengthen its foothold in the automatic and high-performance computing industries.

Valuation

In terms of valuation metrics, TSMC’s are largely positive compared to the sector average and in contrast to their key competitors. Starting with the forward Price to Earnings (FWD P/E) ratio, TSMC stands at 20.19, which is a notable 21.24% less than the sector median of 25.63. When you think about TSMC’s market dominance and technological leadership, this lower P/E ratio points towards undervaluation, indicating that now might be a good time to invest in TSMC while it’s cheap before the company reaches a proper valuation. Moreover, Intel Corporation (INTC) and GLOBALFOUNDRIES Inc. (GFS) – two of TSMC’s main competitors in the semiconductor space – both have FWD P/E ratios far higher than the sector average. This suggests that these companies are overvalued and therefore less promising investments than Taiwan Semiconductor Manufacturing Company Limited.

Moving on to the P/B ratio, TSMC’s figure of 5.01 is an astonishing 58.57% higher than the sector average, and also significantly higher than Intel’s P/B ratio of 1.72 and GlobalFoundries’s ratio of 2.66. While this higher P/B ratio might indicate that TSMC’s stock is expensive relative to its book value, I find it more likely that this suggests a lot of positive optimism in the market about TSMC’s asset base. With the market valuing TSMC’s assets higher than its peers and the sector average, it seems like the company is expected for strong future growth and impressive utilization of its assets.

Potential Risks

While Taiwan Semiconductor shows great promise and potential for long-term growth, there are still several possible shortcomings in investing. TSMC management has put a lot of short-term financial strain on the company by heavily investing in cutting-edge 3-nanometer technology. Although this investment is likely to promote long-term growth if this technology doesn’t meet market expectations or faces adoption delays. TSMC’s financial performance could suffer.

Despite its highly strategic expansion into the United States and Japan, the bulk of TSMC’s operations and production will remain in Taiwan. The company is primarily based in a region marked by geopolitical instability is concerning, particularly if tensions escalate to extremes between Taiwan and China. Any conflict or heightened tensions have the potential to disrupt the chipmaker’s operations, which would not only be detrimental to investors but also to the global semiconductor supply chain.

Moreover, the cyclical nature of the semiconductor industry could prove potentially problematic to TSMC due to the company’s “pure-play” foundry business model. By relying heavily on its clients’ design innovations, rapid changes in market demand or technological shifts have the possibility of damaging TSMC’s profits. Moreover, TSMC’s sector dominance and financial success might be impacted if major technology firms ramp up in-house chip production.

On a similar note, TSMC faces stiff competition in the semiconductor industry that investors shouldn’t ignore, primarily from Samsung and Intel. Both of these companies have been heavily investing in advanced technologies and working to overtake TSMC as the leader in the semiconductor space. Whether it be through Samsung’s advanced processing abilities or Intel’s emphasis on its foundry services, both companies have the potential to impact TSMC’s market dominance and profitability.

All of these risks are most certainly real, but a lot of them are largely speculative and shouldn’t over-concern investors or overshadow the positive gains TSMC has been making recently. The company has been defined by its strategic adaptability, technological leadership, and important political and client relationships. Its geographical expansion into the US and Japan should be seen as a positive step in countering geopolitical risk. Moreover, the company’s investments in advanced technology place TSMC in an ideal position to outperform competitors and navigate the cyclical challenges of the semiconductor industry. Even in the face of all these risks, TSMC is most definitely an attractive buy for investors who want to profit off the AI boom and navigate the complex dynamics of the semiconductor space and the geopolitical landscape.