To The Moon

Summary

• Taiwan Semiconductor Manufacturing Company Limited's weak guidance reflects the ongoing downturn in the semiconductor industry, but the stock is still trading at a decent price.

• Despite the negative sentiment in the smartphone market, the company expects a strong ramp-up in demand in the second half of the year.

• The company's focus on AI and its investment in new technologies like N2 and the Arizona plant position it well for long-term growth.

Annabelle Chih

Investment Thesis

With what I think was an unsurprising Q2 earnings report, Taiwan Semiconductor Manufacturing Company Limited $Taiwan Semiconductor Manufacturing(TSM)$ tumbled on weak guidance suggesting the downturn is still affecting its operations, which we knew already from the previous quarters. I argue that the company is trading at a decent price even after a slight run-up and that it is an essential part of any long-term portfolio, as the company is essential to many large players in the world and the future in terms of developing new, cutting-edge products is bright.

Briefly on Results

A lot of people are saying the report was awful. It wasn't good, sure, but were people expecting an increase in revenues? The CEO in the last earnings call already guided for a much softer outlook, revenue guidance came at pretty much the midpoint ($15.68B), while gross margins came in at the higher point of the guidance at around 54% and higher than the guidance by 50 bps on operating margins.

I covered TSM stock back in April '23, when the same whistle was blown after the Q1 earnings: weak outlook because of inventory build-up and negative sentiment in the semiconductor sector, which was going to persist for at least the rest of the year. I wasn’t surprised that the management guided us to a weaker outlook yet again. In the previous article, I covered a lot of the tensions between China and Taiwan, which I think are overblown still, so I won’t get into that.

Apple $Apple(AAPL)$ reported weaker numbers on iPhones, and the stock is down because of that. There’s clear cyclicality in technology every year, and it is discussed in this article. I’m sure that AAPL is not the only one that is exhibiting such a performance. Qualcomm $Qualcomm(QCOM)$ got demolished for its weak Q4 guidance and the ever-lingering threat of losing AAPL.

I think q-o-q numbers are just too short-sighted and should be taken as a good time to add on the weakness just like now because, in the long run, the potential of TSM is enormous in my opinion.

Outlook- The Long Game

The company is not standing around to be overtaken by Intel $Intel(INTC)$ or some other company in the industry. The announcement of its newest R&D hub in Hsinchu for over 7,000 staff of R&D employees means the company is trying to maintain its competitive edge. The center will be the home of cutting-edge process technology at 2 nanometers and beyond. The employees can expect to be housed there from September to begin the next journey of advancements in the semiconductor industry.

This is great news for the advancements in N2 technology, which is still slated to be in production in ’25. In the same earnings call, the management said that the N3 and N3E are performing very well and are seeing “robust demand and expect a strong ramp up in the second half, supported by HPC and smartphone applications." This tells us that even though the negative sentiment in the smartphone market is still lingering, it seems that we have seen the through and the demand will start to pick up in the 2nd half. N3E has passed all the tests and will be going into production in Q4 ’23. N3 along with N3E should be providing continuous revenue streams for the company for years to come, at least until new technologies like N2 come into production.

The delay of the Arizona plant to 2025 is just going to delay the progress slightly but it is not a deal breaker. The company is looking for top talent for this new plant so it will not compromise its reputation.

The Buzzword

The management mentioned "AI" in their opening statements 7 times this quarter, compared to 0 last quarter, so we're seeing the company jumping on board the hype train, although it feels a little late. I suppose better late than never, right? This could present a really good revenue stream if the company's calculations of "50% CAGR over the next 5 years” are any indication of its potential. Because of these forecasts, the company is acting quickly to meet the ever-rising demand for AI by investing $2.9B in an advanced packaging facility in Taiwan, which will roughly double its capacity.

The company forecasts this growth will contribute to “low teens percent” of total revenues. Right now, this segment accounts for approximately 6% of total revenues, so it will become quite a substantial stream in the next decade. It is hard to predict what kind of efficiencies the AI boom will contribute to businesses and their operations, however, even in the short to mid-term this should contribute substantially if, in the long run, it turned out to be a fad.

In summary, I think the long thesis is still intact, with a lot of promising outcomes from the continuation of N3 and N3E products, advancement of the N2 production and beyond, and the new Arizona plant will be a good addition for TSM and U.S., a win-win.

Risks

I think the biggest short-term hurdle will be the persistent downturn in the smartphone segment that could go on for much longer than early ’24. This will present more volatility in the share price and fluctuations in the company’s revenues. Since I still believe in the company’s future, I welcome these hurdles, which I think are just short-term noise and an opportunity to add at discounted prices.

Briefly on Financials

TSM still has a very solid balance sheet, with around $48B in liquidity against around $29B in long-term debt. The current ratio has improved to around 2.4, which is kind of pushing it in my opinion a little. I’d prefer the company stay within the 1.5- 2.0 range, which would suggest to me the company is being very efficient with its assets, however, 2.4 is still reasonable and not too high. It makes sense it would be higher now, since this way the company can be protected from further headwinds/downturns in the global economy.

In terms of efficiency and profitability, TSM is still very strong in these categories, although a slight dip was expected because of the volatility and negative sentiment in the sector. I would expect these to pick up sometime in '24. This still tells me that the management is utilizing the company’s assets and shareholder capital efficiently and is creating value. The moat and the competitive edge are still intact and very healthy in my opinion.

Seeking Alpha

In my opinion, the company has one of the better balance sheets I’ve seen, and the management is doing a commendable job of operating the company so well even during such times as we saw in ‘22 and ’23 so far.

Valuation and Closing Comments

My fair value for the company, therefore, hasn't changed much since April. The company is up around 14.5% since my first article and is currently trading at my assigned fair value.

Intrinsic Value (Author)

I believe that even at this price, the company is a strong buy, and I would welcome any further drop in price due to volatility caused by further uncertainty in the global economies. I am looking to pick up some shares in the upcoming weeks because I think it's a no-brainer long-term hold. There is a good possibility the price will continue to come down, seeing what is happening with the U.S., with the downgrade of the U.S. debt, and the resilient job market.

The company is still the dominant player in the industry, and I don’t think that is going to change anytime soon because Taiwan Semiconductor is not going to sit still and be beaten by the competition. That is why my bet on the long-term is, I think, a smart bet.

Source: Seeking Alpha