Taiwan Semiconductor Manufacturing Company: An Undervalued Market Leader With A Multi-Year Growth Runway (NYSE:TSM)

The Taiwan Semiconductor Manufacturing Company Ltd. (TSM) is the world’s first and largest dedicated semiconductor foundry. It is also the lead player with a market share estimate of between 51.5% and 53.9%. In distant second place is Samsung Electronics (OTC:SSNLF) (OTC:SSNNF), with an estimated 17.4% to 18.8% share of the market. What makes TSMC unique is that it has managed to stay ahead of the pack since it was founded in 1987, and it continues to invest heavily in advanced wafer technologies and processes to maintain its lead and strengthen its position in a growing segment.

Source: Statista

How Big is the Foundry Market and How Fast is TMSC Growing?

The global semiconductor foundry market is projected to grow from around $42 billion in 2019 to over $62 billion in 2025 at a CAGR of 6.75%.

By comparison, TSMC grew its Q2-20 revenue by 28.9% and H1-20 revenue by 35.2%, both over their prior periods in terms of NT$ (New Taiwan dollars.) Although there was a prolonged decline until Q1-19 in quarterly YoY revenue growth, positive growth returned in Q2-19 and double-digit YoY revenue growth has been reported since Q3-19 in NT$ terms. It’s clear that TSMC is outperforming the overall market by a significant margin in recent quarters, specifically in H1-20.

Source: AnandTech

As of H1-20, TSMC had the highest EUV or Extreme Ultraviolet installed base at 50%, as well as 60% of global wafer capacity, which shows its dominance of the semiconductor foundry market.

Short-term Growth Indicators

H2-20 is also shaping up to be a period of strong revenue growth, and there are a couple of reasons for this:

First of all, Apple, Inc. (AAPL) has tapped TSMC’s entire 5nm capacity for its A14 Bionic chip in the upcoming iPhone 12 and other devices, in addition to future iMac and MacBook models. Apple is believed to have contributed as much as 20% to TSMC’s top line in FY19, and we should expect similar results in H2-20 with the imminent launch of several core devices.

Second, after Apple moved up the nano-ladder to TSMC’s 5nm node, other customers quickly jumped on 7nm bookings. Advanced Micro Devices (AMD) is expected to take the lion’s share and will become TSMC’s largest 7nm customer in H2-20.

For Q3-20, the company has guided for revenues of between $11.2 billion and $11.5 billion, which represents a growth rate of between 7.9% and 10.8% on a sequential basis compared to $10.4 billion for Q2-20, and between 19% and 22.3% on a YoY basis compared to $9.4 billion in Q3-19.

Monthly revenue figures for July and August 2020 show YoY increases of 25% and 16%, respectively. Revenue for the first two months of Q3-20 already stands at $8 billion against $6.7 billion for equivalent the year-ago period, representing a growth rate in excess of 19%. September 2019 revenue came in at $3.55 billion; simply matching that again this year will allow the company to beat the upper end of its own guidance. Assuming even a conservative 10% growth in YoY revenue for September 2020, quarterly revenues for Q3-20 should come in strong, at around $11.9 billion against a consensus estimate of $11.8 billion.

Note: The calculations above use the Oct 8 TWD-USD exchange rate of 0.0348161 from XE.com. TSMC typically uses rates from other official sources and notes them as being “solely for the convenience of the reader,” so there will be some variance. Additional variances will also arise from foreign-currency-denominated receivables and payables. Nevertheless, the calculations show a high probability of guidance-breaking numbers at the top line.

Overall, TSMC expects revenue growth at around 20% in USD terms despite possible headwinds from U.S. regulatory challenges and uncertainties around the pandemic:

In the near-term, we will work dynamically with our customer to minimize the impact to our business from new US regulations. In the mid to long-term, we believe the underlying megatrend of 5G-related and HPC applications remain intact, and supply chain can adjust and rebalance themselves. With our technology leadership, we are well positioned to capture the mid to long-term growth opportunities.

In Q3-20, the company also expects the 5nm and 7nm nodes to be significant revenue drivers, benefiting from growth in 5G smartphone launches, HPC (high-performance computing), and IoT applications.

Long-term Growth Indicators

Looking at broader market indicators, the landscape indicates strong growth in several areas.

In 5G, several OEMs have already released their flagship 5G models, and several more are due for release this year, including the iPhone 12 and the Google Pixel 5. Longer-term, the market for 5G, which is expected to hit $41.5 billion this year, is projected to grow at a 43.9% CAGR through 2027, representing a huge opportunity for TSMC. This includes not just smartphones but a full array of industries that will eventually depend on 5G, such as media, retail, manufacturing, retail, energy, logistics, construction, real estate, banking, healthcare, and many more.

The 5G market is currently skewed toward 7nm and 5nm wafer technology, but we should eventually see a shift toward 5nm and 3nm, and beyond. This is where the longer-term revenue growth for TSMC will come from. At the moment, 7nm is the focal point of the overall market, pulling in 36% of Q2-20 wafer revenues, but H2-20 is expected to see strong demand for 5nm and contribute about 8% to overall revenue in FY-20. Since Apple has already booked the company’s entire 5nm capacity for H2 2020, TSMC will be looking to invest even more in capacity expansion ahead of the demand surge in FY-21. However, there’s still a huge demand for 7nm wafers on the back of rapid growth in AI and ML (machine learning), both of which markets are expected to grow at CAGRs of over 40% over the next several years.

Capex of $10.6 billion was reported for H1-20, and full-year Capex has now been raised to $16 billion to $17 billion. Capex is essentially laid out based on the company’s growth projections for subsequent years, so the Capex raise is another indication of strong momentum over the next few years, which will include N3 production. TSMC has planned for risk production of the N3 node for next year, with volume production expected in H2-22:

N3 risk production is scheduled in 2021 and volume production is targeted in second half of 2022. We have already demonstrated 256-megabit SRAM functionality. N3 logic test chip is fully functional with yield ahead of plan.

Investor’s Angle

The growth momentum we should see over the next several years relies heavily on the investments made this year toward capacity expansion, as well as future Capex outlays. As such, a quick look at the financials would be in order.

As of June 30, 2020, TSMC had a current ratio of 1.4 and a quick ratio of 1.2, implying adequate liquidity to address short-term commitments. With no significant debt on the books and strong cash flows from operating activities of $12.4 billion for H1-20, TSMC’s financial position is solid. Free cash flow for Q2-20 was reported at

The company paid $4.3 billion in dividends for common stock in the same period for a payout ratio of 55%. Yield currently stands at around 2% but the 10-year growth rate of 16% and 3-year growth rate of 29% indicate sound capital allocation practices despite the capital-intensive nature of the business. As a result, the total return figures for the 1-year, 3-year, and 5-year period stand at 87%, 149%, and 364%, respectively. Price return for the same periods comes in at 82%, 124%, and 291%, respectively.

ChartData by YCharts

From a relative valuation standpoint (see above), TSM looks extremely undervalued for the kind of revenue growth we can expect to see in the next few years, as well as the strong earnings growth trend over the past few quarters (see below.)

Source: Seeking Alpha Charting

In terms of the trade tension between the U.S. and China, TSM stands to gain in a major way from regulatory challenges facing companies like Semiconductor Manufacturing International Corp. (OTCQX:SMICY).

Despite a buy rating from several analysts, most price targets appear to be overly pessimistic. TSM has the scale of operations and the supply chain flexibility to adequately address any new U.S. restrictions, and the negative impact is likely to be minimal. Moreover, the New Taiwan dollar has been strengthening against the USD on the back of the semiconductor industry in Taiwan, and TSM is a significant part of that.

Source: XE.com

None of these factors appear to be priced into the stock but the market is quickly waking up to the reality of TSM’s long growth runway from this point forward. The stock has rallied more than 7% between Oct 2 and Oct 8, showing significant upward momentum. Getting in at this time could mean enjoying a triple-digit total return in just a few years, and I hope this article has adequately highlighted the company’s growth trajectory toward that end.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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