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Investment Thesis
Taiwan Semiconductor (NYSE:TSM) is the world's preeminent foundry for leading-edge semiconductor nodes. Much has been said about TSMC's prowess in the foundry market. The company has undoubtedly entrenched its leadership in the high-performance computing (HPC) and Smartphone segments. The company is so confident of its market leadership that it announced a multi-year $100B CapEx capacity expansion plan.
Under Intel CEO Pat Gelsinger's IDM 2.0 master plan, Intel (INTC) aims to retake foundry leadership by 2025. As a result, Intel has been making big moves in CapEx expansion recently. It's also primed to be the first production user of ASML Holding's (ASML) high-NA Extreme ultraviolet lithography (EUV) technology in 2024. Just recently, Intel unveiled its 4nm Loihi 2 Neuromorphic research AI chip. It's a highly advanced AI chip. Importantly, it's also the company's first-ever EUV chip on its Intel 4 process node. Hence, Intel is stepping on the accelerator against Samsung (OTCPK:SSNLF) and TSMC.
Therefore, in this article, we will share our thoughts on whether Taiwan Semiconductor remains a buy for investors.
TSM Stock YTD Performance
TSM stock YTD performance (as of 1 Oct 21).
TSM stock started in 2021 strongly. It kept pace with INTC stock, as Nvidia (NVDA) stock and Advanced Micro Devices (AMD) stock struggled to gain momentum. However, like INTC stock, TSM stock's momentum has faded dramatically. NVDA stock continues to lead the market with a 59% YTD lead. In contrast, TSM stock is significantly lagging behind the market and its peers with just a 3.26% YTD gain. It's even behind INTC's 10.14% YTD return.
In summary, TSM stock has not done well this year. Moreover, the stock is currently undergoing a major consolidation phase. Therefore, we think it's apt to investigate whether investors can take advantage of this phase to add exposure.
TSM Remains Unmatched in Foundry Leadership
Worldwide Foundry Market Share. Data source: TrendForce
Leading Taiwanese Foundry Market Share. Data source: Various sources (Company reports; ISTI-ISTR); TSIA
Taiwan Semiconductor is the world's leading foundry player. It continues to dominate the global foundry market with a 52.9% share in Q2'21. Its leadership has remained consistent over the last 2 years. Samsung foundry is its closest competitor with a 17.3% share, while GlobalFoundries came in third. However, GlobalFoundries is not involved in leading-edge production. TSMC and Samsung dominate that. Intel's return with IFS is likely to shake things up here. Intel, TSM, and Samsung are the only players with leading nodes production capability. Intel has already telegraphed its plans to compete for business with TSM. We think Intel remains in good stead to compete aggressively with Samsung as the #2 before 2024. Without Apple's orders, Samsung foundry has often found it challenging to compete against TSM.
Moreover, Samsung's profits have been driven chiefly by its memory segment. According to Digitimes, "more than 90% of the profit of the entire semiconductor division comes from its memory business." Samsung recognizes the importance of diversifying into the logic business. Memory is too much of a "commoditized" segment. However, Samsung foundry's lack of success against TSMC has been perplexing. Despite Samsung being the #2 player, there seems to be a significant gap between Samsung and TSMC.
Intel is expected to be a much stronger competitor. The company recently completed its groundbreaking ceremony on its new leading-edge Arizona fabs. Fab 52 and Fab 62 represent the critical thrusts of Intel's FY22 20B CapEx expansion in Arizona. Moreover, Intel also telegraphed its plans to spend up to $95B in Europe over the next decade. Intel would focus all this spending on its aggressive CapEx expansion for IFS.
Moreover, we highlighted earlier that Intel has started to use EUV on its Intel 4 node for its Loihi 2 processor. EUV has been a critical differentiator for TSM's leadership. There's little doubt that TSM is still ahead. However, the gap is expected to close. Intel has the resources and wherewithal to spend to catch up with TSMC. We think IFS represents a credible challenge to TSM's leadership. But it's still too early to tell whether Intel can supplant TSM's leadership. We explained in an earlier article that we don't think it would happen.
TSMC is a vital company for the Taiwanese government. It accounted for 20% of Taiwan's total private investment in 2021. If the company flourishes, Taiwan's economy does well. It's straightforward. Moreover, Taiwan sees TSMC as a hugely strategic player in the geopolitical space. The government believes that TSMC's survival is fundamental to Taiwan's relevance and security. Therefore, it's very difficult to imagine a weaker TSMC in the eyes of the Taiwanese government. Taiwan Semiconductor must maintain its market leadership. The government is likely to do all it can to support TSMC in its quest.
However, we think Intel might be strong enough to surpass Samsung as the #2. It might also pose significant challenges against TSMC. That might be all that matters to weaken TSMC's hold. Therefore, for TSMC investors, it might be an essential exercise to consider the impact on its future growth momentum.
Waiting time for chip delivery. Source: Susquehanna Financial Group, Bloomberg
For now, there's nothing for TSMC to worry about, we think. Chip equipment sales show that demand remains robust worldwide. In addition, inventories remain at 2016 levels, and the wait time for chip supply has extended to 21 weeks in August. IHS Markit also emphasized that:
Anecdotal evidence pointed to ongoing increases in demand for semiconductors from around the world. The near-term pricing outlook for the remainder of 2021 for semiconductors and components is that supply shortages are likely to continue to translate into price escalation. (from Bloomberg article)
Indeed. TSMC recently hiked its prices for its chips. It was a smart move in a tight supply situation. The company could use the additional revenue to offset its ambitious $100B CapEx plans partially. Moreover, it could also help to discourage its customers from "double-booking." "Double-booking" threatens to skew the actual demand-supply imbalance. Importantly, TSMC might end up creating much more supply than necessary. That would leave TSMC with an unenviable situation in the future. Hence, we view the latest move as both strategic and tactical at the same time. It's a good move as its customers would gladly embrace the higher prices. In addition, it helps to alleviate the demand-supply imbalance, reducing the potential for a supply glut that could devastate the industry.
Nevertheless, we highlighted in a recent article that investors should also heed the warning of Broadcom CEO Hock Tan. Tan clearly emphasized that he sees the potential of a supply glut transpiring sometime in 2023. He thinks supply would likely be tight till then. But once all that "supply comes online," investors might need to be prepared for a prolonged glut. Hock Tan warned:
And to answer your question point-blank, I do not see any specific drivers or reasons why the strength we see today is really nothing more than of an exaggerated up-cycle. I think we are at a stage, and I think there's nothing that would tell me otherwise, that we will not, over time, revert back over the next 10 years that is as we had the last 10 years, revert to - into an industry, the semi industry, that's really growing at GDP plus. And that's why I talked before in the past at about around mid-single-digit, 5% global GDP plus a certain amount...So if you want to look at year-on-year growth, '22, I think it will all be largely enterprise, but it'd be all fairly elevated. We always go through a period of digestion. There's no way we can consume on all that forever. And that's what is called a cycle, particularly when we expect supply to come into play out of this - out of the current tightness, but dated back to 2020 to start coming in 2023. And the massive investment and CapEx will start deploying capacity in '23 earliest. Then I see '23 where we have supply. And I think digestion of demand might just start to occur. (Deutsche Bank Technology Conference 2021)
So, is TSM Stock A Buy Now?
TSMC LTM EBIT & est. EBIT mean consensus. Data source: S&P Capital IQ
Readers can easily observe that the semiconductor upcycle tremendously benefited TSMC. LTM EBIT grew by a remarkable CAGR of 34.2% from Q1'19 to Q1'21. However, EBIT growth is expected to slow significantly moving forward. Taiwan Semiconductor's EBIT is only expected to grow at a CAGR of 18.8% from FY21 to FY24.
TSM stock is currently trading at an EV/Fwd EBIT of 21x. That's 15.4% higher than its 3Y historical mean of 18.2x. In addition, it's 30.4% higher than its 5Y mean of 16.1x. In the face of slowing EBIT growth, we don't think its current valuation implies a sufficient margin of safety. Although we remain optimistic about TSM's growth prospects, we would prefer to see a deeper retracement first before adding exposure.
We reiterate our Neutral rating on TSM stock. Therefore, TSM stock is not a Buy now.
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