Investment Thesis
Taiwan Semiconductorsaw$Taiwan Semiconductor Manufacturing(TSM)$ itself engulfed in the ongoing Russia-Ukraine conflict. Analysts and strategists had raised the volume on the rhetoric concerning China potentially mulling about a "forceful reunification" with Taiwan. Some experts believe that Russia's military operation would embolden China to consider invading Taiwan in the future. On the other hand, others think that Russia hid its hand in its communication with China.
The narrative has also caused TSMC stock to give up the entirety of its post-FQ4 earnings spike. Consequently, the stock has fallen back to the critical support level that has sustained its consolidation since March last year.
While no one can ever rule out the risk of a Chinese invasion, we think that remains a highly remote possibility currently. Taiwan's "silicon shield" is a profound defense system that the US and the EU will be highly committed to defending. The US has also committed itself to Taiwan's defense, which is wholly different from the conflict in Ukraine. Therefore, investors must be coherent and logical about the notable differences.
We discuss why investors should capitalize on TSMC stock's weakness due to the Ukrainian crisis and add exposure to this fantastic company.
How Has Russia's Invasion Impacted Taiwan Semiconductor Stock
Readers can refer to the first chart above and observe that TSMC stock has reverted to its 5Y NTM EBIT multiple mean. We presented in our previous earnings update article discussing TSMC's multiple secular trends moving forward. Therefore, the company is tremendously well-positioned as the industry's dominant leading-edge foundry in capitalizing on these opportunities.
Therefore, we think its business model is much more robust than what it was five years ago. TSM stock is trading at an EV/NTM EBIT of 17.4x, just slightly ahead its 5Y mean of 16.8x. Furthermore, the stock's most conservative consensus price targets (PTs) were also upgraded after its solid FQ4 card. As a result, TSM stock has dipped markedly below even its most conservative PTs, as seen above. Thus, we think the market has abruptly discounted TSM stock over the possibility of a potential China invasion to unify Taiwan.
Bloomberg also reported the jittery felt by the market over Taiwanese stocks as investors rushed to execute put hedges. Bloomberg highlighted (edited):
The put-to-call ratio on the largest exchange-traded fund that buys Taiwanese equities has jumped to the highest since November. That signals traders are concerned about the island’s stocks, which may suffer if China uses Russia’s invasion of Ukraine as a distraction to ramp up tensions with Taiwan. (Bloomberg)
Should Investors Avoid TSM Stock?
We have been TSMC investors for some time, and we are aware of the risk of war. We think it's critical for investors to consider that possibility no matter how remote it is. TSMC has also indicated the possibility in its risk disclosure as it said (edited):
Operating in the R.O.C. and overseas exposes us to changes in laws, rules, regulations and the enforcements of such laws, rules and regulations in certain key areas that would have a material impact on our operations, such as intellectual property, labor, antitrust, export control, import restrictions, and trade barriers or disputes, as well as the general political, economic, financial and social conditions, outbreak of war or hostilities. (TSMC)
Nonetheless, we don't consider that a significant risk currently or moving forward.Readers can glean from the above that TSMC is a critical foundry for the world in the leading process nodes (16nm and below). These nodes accounted for more than 60% of its FQ4'21 revenue. Furthermore, it has also ramped its 5nm process as its customers have been moving their products to leverage TSMC's solid yields on its 5nm process. Moving forward, as TSMC starts volume production on its 3nm process later this year, the dependence on it will be further entrenched. Furthermore, Intel's (INTC) "shells" are still not ready, and Intel Foundry Services could still be at least 3 to 4 years away from being competitive, assuming that it can. And that's a big if.
Furthermore, Samsung's 3nm process is said to have disappointed Qualcomm$Qualcomm(QCOM)$ so much that it "reportedly plans to contract TSMC to make all its processors demanding 3nm process manufacturing." Qualcomm is facing yield issues with Samsung's 3nm GAA process. Therefore, we believe that TSMC's 3nm will be in hot demand. Don't forget Intel and Apple $Apple(AAPL)$ have already reserved capacity with TSMC on its 3nm process. Qualcomm's archrival MediaTek has also contracted TSMC to produce its next-gen 3nm SoC. Therefore, Qualcomm is not taking any other chances of relying further on Samsung to produce its critical next-gen chips.
In addition, DigiTimes also reported that "Qualcomm has also placed some of its Snapdragon 8 Gen 1 chip orders demanding 4nm process manufacturing with TSMC, according to the media reports. Samsung was previously the sole supplier for the processor." While it's not a departure from its multi-sourcing strategy, Qualcomm realizes why AMD, Apple, and MediaTek rely on TSMC to produce their leading-edge silicon exclusively. So, when it comes to the most advanced chips production technology, Samsung is not even a close second.
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