Taiwan Semiconductor: A 2022 Outlook

Summary

• 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.

BING-JHEN HONG/iStock Editorial via Getty Images

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:

1. 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.
2. 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.
3. 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.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSM either through stock ownership, options, or other derivatives. 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.

Comments

[Julian Beatty]

I think your revenue growth model doesn't quite make sense. When the new fabs come online and start producing wafers, revenue growth should explode. In other words, revenue growth should accelerate in 2023/2024 when fab capacity is expanded, instead you have modeled the reverse.

[BigMichael]

@Julian Beatty there are 29 FABS expected to be in production by 2023. Over 23 million in additional wafer starts. That has the potential for over supply and ASP drop.

[Julian Beatty]

@BigMichael And yet the demand for semiconductors is steadily rising every year. Increased capacity sure, but unlikely we will see an oversupply, especially in the premium bleeding edge nodes that TSMC operates.

[Hung Victor]

@BigMichael ASP of 28nm and above may drop.
While ASP of 7nm, 5nm, and 3nm will not drop before 2024.
All advance process contact deal already done. Intel is currently negotiating 2025 price with TSMC. That means 2024 price already fixed.
Just my 2 cents.

[Dex4Sure]

Long TSM

[Whiterabbit66]

I added some recently, probably a good time now to add a little more.

[afroquest]

Good article - thank you. TSM has been investing for a period of higher structural growth. I think that we will start to see the rewards from 2023.

[ARNOLDMUSCAT]

Thank I am surprised that TSM share price has not increased as much as its competitors, well that is my take?

[VictorN]

@ARNOLDMUSCAT there aren't many pure chip foundry companies to compare against. Sure, TSM stock price performed poorly against GFS, from 10-28 to today.

[User 10400941]

@ARNOLDMUSCAT Some investors fear that mainland China will overrun Taiwan, and others fear that Intel will dominate the fab market. Both scenarios are unlikely. TSMC is expanding international operations. Intel depends on TSMC for 3mn chips, regardless of their self-vaunted roadmap.

[Dex4Sure]

@ARNOLDMUSCAT I mean TSMC is not the kind of company that rides on hype waves, but its a safe bet. TSMC is the absolute leader in logic manufacturing with over 90% market share in the most advanced chips. Eventually market will see the value in TSMC again.