Taiwan Semiconductor Manufacturing Company (NYSE:TSM) is a leading foundry in the semiconductor industry and is investing massively in its business, boding well for revenue and earnings growth over the long-term, and has a reasonable valuation being therefore attractive for long-term investors.
TSMC was founded in 1987 and is based in Taiwan. It has been listed since 1997 and is traded in its domestic market and on the New York Stock Exchange. Its current market capitalization is about $635 billion, being one of the largest companies in the world by this measure.
TSMC pioneered the dedicated semiconductor foundry business model, being the world’s largest manufacturer of chips nowadays. Its market share is about 57% of global chip production, with its main competitor being Samsung Electronics (OTCPK:SSNLF). Most of its factories are located in Taiwan, but have also production in China and in the United States.
TSMC is the most advanced manufacturer in the world, with technology capable of producing the smallest chips nowadays, namely 3-nanometer and 5-nanometer nodes through ASML’s (ASML) extreme ultraviolet technology. Its competitors are also pushing for mass production of 3nm in the near future, with Samsung the best positioned after TSMC, while Intel plans 3nm production by 2025.
However, in 2020, TSMC only generated revenue from the 5nm technology as 3nm has not reached mass production yet, but the weight of advanced technologies (16nm and lower) are rapidly increasing (58% in 2020 vs. 50% in 2019) and this trend is only expected to accelerate in the next few years.
By focusing solely on the manufacturing of chips, instead of designing or distributing under its own brand, TSMC does not compete directly with its customers, which can be an advantage over its peers Samsung and Intel (INTC).
TSMC has a very large number of customers across the world with varied end-markets, which helps to smooth fluctuations in demand and reach high levels of capacity utilization, something that is key to reach high levels of profitability over the long-term. Despite this, about 80% of its production is for smartphones and high-performance computing, while other industries such as Automotive (3% of production) have a relatively small weight.
As I’ve previously analyzed on “ASML: A Fantastic Company For Long-Term Investors”, the semiconductor industry has very good growth prospects over the next few years, supported by new technological developments, such as 5G, Big Data, the internet of things, beyond others.
This means that demand for chips should remain strong for many years, while supply is not exactly catching up. This imbalance was accelerated by the coronavirus pandemic, with demand for smartphones, tablets, laptops and other products, increasing rapidly leading to the current chip shortage. This is something that may take some time to balance as new factories take time to build, but beyond the current shortage demand for chips is expected to remain strong over the next decade, boding very well for TSMC.
Taking into account this industry background, it is not surprising to see that TSMC has increased significantly its investments recently and has very ambitious investment plans for the near future.
Indeed, TSMC’s capital expenditures (capex) have increased in the past couple of years, from an annual value of about $10 billion per year to about $15 billion in 2019 and $17.4 billion in 2020. For 2021, the company is expecting to invest about $28 billion, which is a massive investment in capacity, but more recently TSM announced a $100 billion investment over the next three years in new capacity and research and development. The company justified these huge investments in this way:
We are entering a period of higher growth as the multiyear megatrends of 5G and high-performance computing are expected to fuel strong demand for our semiconductor technologies in the next several years. In addition, the COVID-19 pandemic also accelerates digitalization in every aspect.
This shows that TSMC sees demand for chips to remain strong over the long-term and is not just reacting to the current chip shortage. These investment plans also dwarf its competitors, considering that Intel has recently announced a $20 billion investment in two new fabs, while Samsung wants to invest $116 billion but over a decade.
Therefore, TSMC is only likely to increase its market share in the global production of chips over the coming years, as it seems to be best company poisoned to meet the expected increase in demand for chips from different industries, increasing its competitive advantage to peers.
Regarding its main financial targets for the next few years, TSMC aims to achieve revenue compounded annual growth rate (OTC:CAGR) between 10-15% from 2020-25, gross margin of about 50% and operating margin of 39% and a return on equity ratio above 20%.
Regarding its financial performance, TSMC has a positive track record given that it has reported positive growth figures and a good level of profitability over the past few years and has outperformed the overall semiconductor industry growth.
More recently, the company has benefit significantly from the pandemic and the stay-at-home move, which led to a big increase in revenues and earnings during the past year. TSMC’s revenues amounted to $25.5 billion (+31.4% YoY) and the company showed good operating leverage given that its business margins also increased during the year. Indeed, its gross margin was 53.1% (vs. 46% in 2019) and its operating margin improved to 42.3% (vs. 34.8% in 2019), which led to a higher increase in earnings than revenue in 2020.
TSMC’s income before tax was up by an impressive 50% YoY to $20.5 billion, while its bottom-line amounted to $17.6 billion (+57% YoY) setting a new record high and its return on equity ratio was close to 30%, a level that was not reached since 2010. Even though TSMC’s earnings growth was impressive, its free cash flow generation was even better given that FCF doubled from the previous year to close to $10 billion.
These impressive growth figures clearly show that TSMC benefitted from higher demand across the world for consumer electronics, something that is a one-time boost and TSMC is not expected to grow its earnings 50% every year in the future. Nevertheless, the long-term growth prospects are good and this is reflected in current consensus estimates for the coming years.
According to analyst’s estimates, TSMC is expected to grow its revenues considerably in the near future, from $45.5 billion in 2020 to about $80 billion in 2024. This is a CAGR rate of about 15.2%, which is quite impressive for a large company like TSMC. This clearly shows that the semiconductor industry has great growth prospects and, as the leading foundry, TSMC is one of the companies that will certainly benefit from this.
Regarding its balance sheet, TSMC has a very strong position given that it has more cash than long-term liabilities in its balance sheet, a profile that has not changed for many years. This means that TSMC has a net cash position, a very healthy financial position which allows it to continue to invest massively in its business growth while at the same time return capital to shareholders.
The company is committed to deliver a sustainable and growing dividend and has a very good history since it started to distribute dividends in 2004, and have never reduced its annual dividend since then. TSMC pays a quarterly dividend, which currently was set at $0.45 per share, which at its current share price leads to a dividend yield of about 1.5%. This is not an impressive yield, but compared to other technology stocks is not bad, but most of future returns should come from share price upside rather than dividends.
TSMC is a company with strong fundamentals and a market leader position in the foundry business, having good long-term growth prospects despite its already large size. Despite this profile, TSMC is trading at 26x 2022 earnings estimates and EV/EBITDA of 14x according to Bloomberg, at a discount to its peer group.
I think this valuation is quite attractive and TSMC seems to be a good long-term investment in the semiconductor industry right now. ASML is one of my largest holdings in my portfolio and in the short-term I want to diversify my portfolio towards other sectors, but TSMC is certainly a stock on my ‘watch list’ and I may start a position in the next couple of months.
This article was written by
I invest with a long-term perspective in industries/themes that have secular growth prospects and should deliver strong returns in a time frame of 10-15 years. Currently, I'm invested in Digital Payments/Fintech, Semiconductors, 5G/IoT/Big Data, Electric Vehicles, and the Metaverse.
Disclosure: I am/we are long ASML. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.