- A number of macro tailwinds will continue to push demand through 2022 across high performance computing, automotive, and IoT.
- While inventory correction and geopolitical risks are valid, they remain minimal in the short term.
- Valuations continue to support investment opportunities for adding shares.
Robust demand for TSMC chips will continue in 2022 from multiple tailwinds
Taiwan Semiconductor Manufacturing Company (NYSE:TSM) has demonstrated considerable growth through 2021, with a +17.2% y/y increase in revenue over 2020 through November YTD. This strong growth is likely to carry over into 2022, with CEO C.C. Wei confirming on the 3Q21 earnings call:
We are entering a period of higher structural growth. The multiyear megatrend of 5G and HPC-related applications are expected to fuel a massive requirement for computation power.
TSMC has reported strong demand across all of the major subsectors which it operates in: Smartphones, HPC (high performance computing), IoT and automotive-related applications. And while the smartphone market may be in a more mature state, there is a real opportunity for multi-year growth across the other three end markets.
- HPC end markets will continue to grow at a ~8% CAGR through 2025 to a >$40bn market, according to Hyperion Research - this is inclusive of multiple sub-markets across servers, data storage, middleware, and applications
- 5G will continue to spur IoT growth in this coming decade - McKinsey projects that 5G IoT units will increase from 3mln in 2022 to 248mln by 2030. Applications range from automated systems in factories to medical devices, cameras, and other B2B applications
- Rapid changes in the automotive industry over the past few years now require more advanced semiconductors to support the emergence of electric vehicles and automation of automobiles. With increased demand for sensors, memory devices, and other advanced technologies, Mordor Intelligence expects this $37bln market to grow at ~17% CAGR through 2026
Despite TSMC's dominance in the chip space, at 54% of total foundry market share and >90% market share of advanced chips (7nm and below), there are untapped opportunities. In the latest earnings report, TSMC notes that the company only participates in 15% of the global automotive IC market, and IoT currently only accounts for 9% of TSMC's total revenue.
Taiwan Semi is positioned well to capitalize on these growing markets, as it continues to consistently lead the pack in the latest chip technology. Against its largest competitor, Samsung, TSMC was able to mass produce 7nm and 5nm chips earlier with higher chip yields. On top of a $100bln capex commitment across the next three years, TSMC is poised to continue its technological advantage.
Inventory correction and geopolitical risks exist but are unlikely in the short term
During a period of significant shortage, there is always the risk that the demand could reverse in the medium term from overproduction - but it is unlikely. TSMC management maintains confidence that a downturn is unlikely, with a few considerations:
- Across the board, customers are likely to prepare for higher inventory levels going forward to provide supply security, given what they've seen with supply chain disruptions when a shortage occurs.
- Chip lead times have increased on average 75% to 52 weeks for customers - it is expected that this will not stabilize until at least 1H2023.
- Much of the demand represents new opportunities and applications, not just increased volume from existing lifecycles of products such as smartphones. Even before the warning signs from COVID foreshadowed a shortage of chips, as early as 2019 McKinsey published a paper about the role new technologies would play in semiconductor foundries over the next decade. This included the projection that foundries could capture 40-50% value of the total technology stack from AI; McKinsey predicts AI to be a $67bln revenue opportunity for global foundries by 2025 (18-19% CAGR).
Oversupply should not be a concern, particularly for a leading semiconductor foundry like TSMC. From a geopolitical perspective, the situation appears more contentious, as Taiwan is stuck in a tug of war between China and the US.
Despite China's increasing military presence and confidence, an invasion is unlikely in the near future. One reason is the difficulty of such a military advance - Taiwan's "highly defensible" terrain includes a lack of decent landing spots for ships given the rocky, mountainous east coast and just 14 potential beach landings. Taiwan's entire national defense strategy is specifically targeted at defeating such an invasion.
But an even greater deterrence is the prospect of the United States intervening in response to a move that would shake up a global supply chain. Both the US and China are heavily dependent on TSMC for chip manufacturing, and an acute move from either country is likely to draw serious political consequences. To date, China has not shown any indication of expanding its landing ship force, and such a motive would go against what President Xi has praise of the CCP's status of prosperity and stability. Even if there is a long term risk, it is highly unlikely that China would be able to pull off a sudden invasion in the short term.
In a worst case scenario where we did see such action, the impact would likely affect the broader equity markets, and not just shares of TSMC.
Updated valuations from TSMC guidance still show favorable opportunity
Modeling in a $100bln capex plan does weigh a bit on earnings, but with TSMC guidance of revenue and gross margin for 2022 from the proposed 20% price hike, there is still ~13% upside over current share prices from a quick free cash flow model:
Source: Author's Calculations, with TSMC's 2019 and 2020 20-F filings
I do think that there is upside to this initial valuation; TSMC's revenue guidance could be conservative, given the 20% price hike and increased demand that will keep fab utilization rates high. Plus, TSMC's AA-/Aa3 credit rating allows for a substantially low cost of borrowing, which they could use to tap the debt markets to fund its capex plan if it needs (and lower its total cost of capital).
TSMC remains an attractive investment heading into 2022 as a technological leader in semiconductor contract manufacturing, with the emergence of new end markets that will continue to push demand.
This article was written by
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