Could TSMC be the eighth company added to the Magnificent Seven?

• When investors think of the Magnificent Seven, they will primarily associate it with large-cap stocks that delivered outsized returns in 2023, driven by optimism in AI.

• Therefore, TSMC( $Taiwan Semiconductor Manufacturing(TSM)$ ), the large-cap AI chip maker, has the potential to be named as the eighth company added to the Magnificent Seven if it delivers a similar outsized return as we have seen in the Magnificent Seven.

Key takeaways from Q4 earnings results

1. 4Q2023's revenue declined 0% year-on-year to TWD 625 billion, while operating income fell 19.95% year-on-year to TWD 260 billion.

2. However, investors are optimistic as they may have witnessed the worst year-on-year decline in revenue and operating income, with growth rates at -19.93% and -26.51%, respectively, in 3Q2023.

3. The operating margin was 41.6% in the latest quarter, and the guidance for the next quarter's operating margin is 39.5% to 41.5%, indicating that there may still be room for the operating margin to fall.

4. Capital expenditures for TSMC was USD 30.45 billion for the year 2023 (compared to 2022 capex at USD 36.3 billion), and the company is budgeting capital expenditure of $28 billion to $32 billion in 2024. We view the potential reduction in capex as positive, and if realized, this would mark the lowest capital expenditure point in four years.

5. Revenue for 2024 should increase in the low to mid-20% range, primarily fueled by robust demand for artificial intelligence (AI) chips, offsetting weak smartphone and electric vehicle sales.

6. The contribution of revenue from AI chips is anticipated to increase to approximately 12-13% of the chipmaker's total revenue over the next five years, propelled by the swift expansion of AI chips with a compound annual growth rate (CAGR) of 50%.

7. TSMC plans to stick to its revenue target of an annual compound growth rate (CAGR) between 15% and 20% in the next few years.

Reason for Optimism in TSMC

• TSMC continues to hold its position as the world's largest contract chipmaker, serving as a key supplier for major tech giants such as Apple and Nvidia( $NVIDIA Corp(NVDA)$ ).

• In summary, TSMC may not be the best play to tap into the AI craze as the revenue growth may continue to be dragged down by slower growth in Smartphone, IoT.

• Nevertheless, we maintain an overweight stance due to TSMC's substantial market share of approximately 90% in advanced semiconductors and it still stand a higher chance of producing smaller chips at better yield rates relative to Samsung and Intel. TSMC currently manufactures 3nm chips and plans to commence 2nm mass production by 2025.

• Other positive factors include a higher utilization rate, a stronger industry recovery driven by AI, market share gains, and valuation expansion in 2024.

• TSMC remains a laggard in share price performance, and its valuation is undemanding relative to the Magnificent Seven. Investors are likely to consider TSMC as one of the best candidates to benefit from the evolution of AI.

• In addition to investing in TSMC directly, investors may also explore the VanEck Semiconductor ETF ( $VanEck Semiconductor ETF(SMH)$ ) to gain exposure to TSMC. Currently, TSMC holds a weighting of 9.54% in the SMH ETF, while Nvidia holds 21.8%.

• Over the past five years, TSMC and SMH have demonstrated annualized returns of 28.62% and 33.29%, respectively, surpassing the S&P 500 and Nasdaq-100, which achieved 14.52% and 21.64% during the same period.