Taiwan Semiconductor: The 800-Pound Chip Gorilla That's An Underappreciated Play On AI

Seekingalpha2023-11-28

Taiwan Semiconductor shares have risen 31% since December, outperforming the S&P 500.TSM's Q3 2023 results beat estimates, with revenue up 10% from Q2 and 5nm device revenue jumping 13% YoY.TSM's ...

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GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4654052-taiwan-semiconductor-the-800-pound-chip-gorilla-thats-an-underappreciated-play-on-ai><strong>Seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Taiwan Semiconductor shares have risen 31% since December, outperforming the S&P 500.TSM's Q3 2023 results beat estimates, with revenue up 10% from Q2 and 5nm device revenue jumping 13% YoY.TSM's ...</p>\n\n<a href=\"https://seekingalpha.com/article/4654052-taiwan-semiconductor-the-800-pound-chip-gorilla-thats-an-underappreciated-play-on-ai\">Source 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31% since December, outperforming the S&P 500.TSM's Q3 2023 results beat estimates, with revenue up 10% from Q2 and 5nm device revenue jumping 13% YoY.TSM's strong ramp-up of 3nm technology and increased demand for 5nm technologies are expected to drive future growth.AYOTOGRAPHY/iStock via Getty ImagesThis article was coproduced with Chuck Walston.Back in December, I provided an article on Taiwan Semiconductor (NYSE:TSM) in which I issued a rare Strong Buy rating. Since then, shares are up nearly 31% vs. a 19% gain for the S&P 500.A follow-up piece I authored in the first week of October provided a Buy rating. After that piece debuted, TSM shares climbed 10.2% as opposed to a 5.5% gain in the S&P.Throughout this year, there have been several key developments. The firm's customers are struggling to adjust their inventories amidst weak smartphone sales. And while there has been an increase in AI-related demand, that did not suffice to offset the cyclical nature of the semiconductor business.Following a gang-buster 2022, these factors contributed to revenue and EPS declining year-over-year but improving sequentially.Looking past last quarter's results, we're likely to see growth driven by the company's strong ramp-up of industry-leading 3 nm technology accompanied by increased demand for 5 nm technologies.A Review Of Last Quarter's ResultsTSM provided Q3 2023 results on Oct. 19. Q3 GAAP EPS of $1.29 beat analysts' estimates by $0.13, while revenue of $17.28 billion beat consensus by $580 million.Despite the twin beats, Q3 revenue was down 14.6% year-over-year and earnings declined 24.9% year-over-year. However, revenue was up 10% from 2Q23.Gross margin increased 0.2% sequentially in 3Q23, and 5 nm device revenue of $6.39 billion, representing 36% of total revenue, jumped 13% year-over-year and 36% over Q2.Advanced nodes, defined as 7 nm and lower, constituted. 59% of revenue. This represented a 3% decline year-over-year but an increase of 23% from Q2.Smartphone-related sales of $6.74 billion, representing 39% of total revenue, was down 19% year over year but jumped 30% from Q2.High-performance compute ('HPC') revenue, which constitutes 42% of total revenue, fell 8% from FY 2022 but was up 5% sequentially.Internet of Things (IoT), which comprises 9% of total revenue, was down 23% annually but increased by 24% from Q2.Automotive, which is 5% of revenue, dropped 15% year over year, while digital consumer & data center (2% of revenue), and the Other category (3%) each fell 15% annually.Considering the stock jumped 5% the day earnings were released, apparently investors were focused on the increase in sales over Q2 coupled with earnings growth of 16% since last quarter.Management now guides for Q4 revenue to increase 12.4% sequentially. Assuming that forecast is accurate, that would mean 2023 will be down 5% from 2022.Management guides for capex in a range of $32 billion to $36 billion. Of that, 70% will be devoted to advanced process technologies (N7 and below). The company plans to increase N3 manufacturing capacity in Taiwan and Arizona.TSM has 20% of capex budgeted for fabs producing chips on specialty technologies, with 10% targeted for advanced packaging and mask production.What Caused The Surge In Revenue?The impetus for the jump in Q3 revenue can be found in a single statement provided during the earnings call.Third quarter revenue increased 13.7% sequentially in NT dollars or 10.2% in U.S. dollars as our third quarter business was supported by the strong ramp of our industry-leading 3-nanometer technology and higher demand for 5-nanometer technologies…Wendell Huang, VP & CFOOn the positive side, the sales growth of 3-nanometer ('NM') and 5-nanometer chips bodes very well for TSM over the long haul.Although the company only generated 6% of revenue from 3nm chips last quarter, management estimates the market for 3nm chips could hit $1.5 trillion within five years of entering volume production.Considering Samsung (OTCPK:SSNLF) and TSM are the only foundries producing 3nm chips, that means the two are a duopoly in that arena, with all the pricing power and profit margins that entails.Unfortunately, there's a potential, albeit short-term, negative related to the recent surge in 3nm demand. It's assumed that Apple (AAPL) booked at least 90% of TSM's 3nm process production capacity for 2023.It's also estimated that Apple's MacBook and iPad shipments declined by 30% and 22%, respectively, this year. Now factor in that about 23% of TSM's revenue is from Apple.Even so, longer-term demand for 3nm chips is assured. Furthermore, there are additional growth drivers for TSM.During the Q2 earnings call, management provided insight into the potential AI holds for future growth.Today, server AI processor demand, which we define as CPUs, GPUs and AI accelerators that are performing training and influence functions accounts for approximately 6% of TSMC's total revenue. We forecasted this to grow at close to 50% CAGR in the next 5 years and increase to low teens percent of our revenue.C. C. Wei, CEOI'll note here that investors are all agog regarding Nvidia's (NVDA) growth potential; however, there seems to be a bit of a disconnect in that TSM makes all of NVDA's chips.With 10% of TSM's revenues stemming from NVDA, that which drives growth in the latter firm also benefits the former. However, to date TSM's share price hasn't been impacted by the industry's move to AI.NEKKEI AsiaAdd to that reports that NVDA will use TSM's 3nm process for its Blackwell architecture to manufacture its next-generation AI processor in 2024. Also, NVDA's H100 AI graphics processing unit ('GPU') uses TSMs 5nm manufacturing node.In the past, NVDA greatly enhanced performance in its data center GPUs, which are used to power AI servers, by using smaller process nodes. Therefore, one should expect the company will adopt TSM's 3nm node to make the next generation of processors.I'm not alone in believing that TSM should experience significant growth due to the adoption of AI.One of the reasons that commodity names and memory chipmakers struggle to thrive is simply because there has been huge displacement and hyperscale (spending) in AI. More dollars are shifting towards Nvidia. TSMC is one of the few players out there you can look at and say look there's a direct connection even if Nvidia is reaping the bulk of the benefit.Matt Bryson, senior VP of equity research, Wedbush SecuritiesUnfortunately, TSM is currently unable to meet AI-related demand. Here's the CEO's response to a question posed during the last earnings call.Charlie, the AI demand continues to grow stronger and stronger. So from TSMC's point of view, now we have about -- we have a capacity limitation to support them, to support the demand.Considering TSM is the 800-pound gorilla in this space, that only means that pent-up demand today will drive greater demand tomorrow. That's because the company is on track to double its advanced packaging capacity by the end of 2024.Debt, Dividends And ValuationTSM's debt is rated AA-/stable by Standard & Poor's and Aa3/stable by Moody's.Last quarter, TSM had $51.7 billion in cash and cash equivalents and $29.2 billion in debt.The stock yields 1.80% with a very low 6.83% payout ratio. The 5-year dividend growth rate is 6.55%.TSM currently trades for $98.41 per share. The average 12-month price target of the 13 analysts that follow the company is $115.17.The forward P/E is 20.39x, a marginal improvement over the stock's 5-year average P/E of 21.51x. The forward PEG is 2.72X.Is TSM A Buy, Sell, Or Hold?There's no getting past the fact that TSM has very high customer concentration. Apple alone constitutes 26% of the firm's revenue, and its top-10 customers accounted for 68% of its revenue.However, Taiwan Semiconductor is the world's largest dedicated contract chip manufacturer, with close to a 60% market share of the foundry industry.FAST GraphsThe firm's lead in high-performance chips designed for AI and accelerated computing processes is much wider, with TSM holding over 90% of the market in that category.This results in TSM posting industry leading profit metrics.Furthermore, the company's 3nm chips provide lower costs, higher performance and power improvements that put the firm at the forefront of the evolution to AI.TSM also anticipates introducing its first 2 nm chips in 2025.I see the current situation, which includes a slowdown in smartphone sales and inventory normalization, as no more than a \"speedbump,\" and I believe TSM will provide long-term and steady revenue growth.Therefore, I rate TSM as a BUY.I have a moderate position in TSM and hope to add to that investment over the coming weeks and months.FAST GraphsA Word Regarding A Possible Conflict With ChinaIt's common for me to read about investors who will not invest in TSM due to the threat of conflict with China.At the same time, although Apple, Nvidia, Advanced Micro Devices (AMD) and Qualcomm (QCOM), to name but a few, rely on TSM for their most advanced products, I do not see similar qualms about investing in those names.I'll also use Starbucks (SBUX) as an example of one of many companies that has a heavy presence in China and generates growth from that country.Add to that a plethora of firms that rely on China or Taiwan as essential links in their supply chains.My point is that the list of major corporations that would suffer mightily should China invade Taiwan is simply too long to list.If I awoke tomorrow to find that China had invaded Taiwan, I would seriously consider selling every stock in my portfolio.Call me a fool, but I believe the market would experience a crash like we have not seen in my lifetime.So… right or wrong, I do not see the threat as a reason to avoid an investment in TSM.Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. 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