Taiwan Semiconductor: AI Exposure With Less Bubble Hype?

Summary

• Taiwan Semiconductor Manufacturing Company has seen a 38% YTD increase, largely due to excitement over its production of Nvidia's GPU chips.

• I wouldn't necessarily buy TSM stock before earnings, but the relative value against American tech peers is instructive about how risk and reward are perceived by investors.

• TSMC makes more income, has a lower market cap, and has a more stable earnings trend than Apple or Nvidia.

  shih-wei/E+ via Getty Images

Taiwan Semiconductor Manufacturing Company $Taiwan Semiconductor Manufacturing(TSM)$ has followed the broader NASDAQ rally this year, rising by 38% YTD. Of course, that's nothing compared to Nvidia's $NVIDIA Corp(NVDA)$ 220% return, but it's a strong return nonetheless. A fun fact about TSMC is that they're the sole supplier of Nvidia's GPU (i.e. AI) chips, although TSMC makes plenty of money elsewhere, chiefly from making smartphone chips for Apple $Apple(AAPL)$. TSMC is much cheaper than its customers– Nvidia trades for 60x non-GAAP earnings after massive upward revisions, while Apple trades for 33x. TSMC trades for roughly 21x forward earnings. TSMC reports earnings on Thursday of this week, giving clues not only to their own business but also into the fortunes of Apple $Apple(AAPL)$ and Nvidia.

Data by YCharts

3x The Net Income As NVDA For 1/2 The Market Cap

The hype over Nvidia obscures the fact that the company doesn't actually make all that much money relative to its valuation. TTM net income peaked at roughly $9.8 billion in January 2022, fell to $4.4 billion by January 2023, and is now running back around the peak level. Yes, the guidance for the current quarter was jaw-dropping, but the wave of AI investment doesn't look that much different in Nvidia's financials from the crypto boom or the data center boom during COVID, just bigger.

Why do we care about net income and not just growth?

1. For one, Nvidia (like most tech companies) typically reports non-GAAP earnings, so financial statement net income is a nice reality check on the actual level of profitability of the company that accounts for huge investments needed in R&D to stay competitive.

2. Second, we can then easily compare net income to valuation. And in this case, after upping guidance, Nvidia should make about $11-$12 billion this year (great numbers by the way) but is valued for $1.2 trillion. NVDA earnings are a moving target, but this should be in the ballpark. On a GAAP basis, that's 100x earnings or more. When/if the chatbot boom fades (or competitors gain ground on Nvidia's technological lead), then shareholders who have super high expectations will be crushed. This is a story that has happened over and over again– we hear plenty from Apple shareholders but nothing from those who went all-in on Research in Motion, the maker of the Blackberry smartphone. Nvidia might win and might lose, but the financial statements tell a story of cyclicality, making the valuation highly suspect. Granted, Nvidia makes a lot more per GPU sold than TSMC does, but they also incur far more R&D costs.

TSMC Offers Relative Value Vs. American Peers

Compared with American peers, TSMC has far more net income available to shareholders, less cyclicality, and a strong long-term trend. Here we have roughly $33.4 billion in TTM net income and a market valuation of $493 billion. Again, the earnings of almost all tech companies are subject to weird add-backs and such, but this is a PE ratio of roughly 14.7x. That's pennies on the dollar compared to Nvidia, and if Nvidia ends up falling behind a competitor in 2-3 years' time, chances are TSMC will be making the chips. This is also likely what drew Berkshire Hathaway (BRK.B) to invest in TSMC, though they sold out earlier this year, citing geopolitical concerns. I'm not sure either of these companies count as good values at this point, but TSMC's valuation shouldn't differ so much from either Apple or Nvidia because the companies are so intimately related.

It's likely that American tech companies are overvalued, TSMC is a good relative value, or both. Analysts have panned TSMC by saying that AI won't move their bottom line much, but the dollar value of profit for Nvidia and TSMC from AI are in the same ballpark– the main difference really is that TSMC made more money in the first place. Another question mark relates to Apple. Taiwan Semiconductor earnings are expected to fall about 20% for FY 2023, but Apple's earnings are expected to hold up. TSMC provides forward guidance, but Apple doesn't. Could this mean that iPhone sales may not be as good as analysts think this year, especially after student loans kick in before the holidays?

Bottom Line

One popular narratives is that Big Tech and AI will conquer the world and deserve nosebleed valuations. This is clear from the difference in valuation between TSM and Apple/Nvidia, and from the difference in valuation between Taiwanese stocks and American tech companies in general. Either Taiwan is too cheap or American tech is too expensive.

Questions For Readers:

1. Does TSMC deserve the deep discount it carries to American tech peers like Apple and Nvidia, despite having similar supply chain risks?

2. Could investors be overestimating the risk of war on TSMC while underestimating the risk on its American customers?

3. Are there any other opportunities in the AI space that are being overlooked?

Feel free to share your thoughts in the comment section!

Source: Seeking Alpha