Taiwan Semiconductor Finds A New Gear On Strong Leading-Edge Demand

When I wrote about TSMC (TSM) (“Taiwan Semiconductor Manufacturing Company”) after second-quarter earnings, I wrote that while the apparent return potential on offer wasn’t bad for a high-quality tech company, I wanted to wait for a pullback. While 10%-plus pullbacks aren’t so rare in TSMC’s history, that was a vain hope given the hot demand for leading-edge (7nm and 5nm) chips for smartphone and data center applications, and TSMC shares are another 30% higher now.

Expectations remain high, but given virtually no spare capacity, increasing scale benefits at 5nm, and no near-term reason to expect weaker demand from customers like Advanced Micro Devices (AMD), Apple (AAPL), Broadcom (AVGO) at the most advanced nodes, not to mention ongoing issues at Intel (INTC), it’s hard to say that those expectations aren’t attainable. TSMC shares now trade at around a 10% premium to SOX versus a historical small discount (0%-10%), but that premium has been as high as 35% in the past. I’m not calling for a near-term tumble in the shares, but this is now definitely more of a near-term earnings momentum story than a long-term value story.

 

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Taiwan Semiconductor Finds A New Gear On Strong Leading-Edge Demand

Taiwan Semiconductor Manufacturing Company Navigating Geopolitical And End-Market Turbulence Quite Well

I said in my last article on Taiwan Semiconductor Manufacturing Company (TSM) ("TSMC") that I'd be more bullish on the shares below $50, and investors did, in fact, get the chance to buy below $50 before the stock lifted off, buoyed by improving sentiment on wafer volumes in 2020 as well as a hard turn toward technology stocks in recent months. With that, TSMC has done a little better than the SOX Index, while a few equipment/supply names like ASML (ASML) and FormFactor (FORM) have done even better.

My only real concern around TSMC remains the elevated level of long-term margin expectations. I don't think there are really any credible concerns about the company's ability to ramp 3nm or 2nm, nor maintain a strong competitive position relative to Samsung (OTC:SSNLF) and other fabs, and I believe that the year-to-year shifts in customer mix are just something that goes with the business. Still, I do see some risk to the sheer magnitude of margin improvement that seems baked into the valuation. While today's price would appear to offer "high-mid-single-digit" long-term annualized return prospects, which isn't bad for a quality tech name, I'd prefer to wait for another pullback, as those aren't uncommon in this stock's history.

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Taiwan Semiconductor Manufacturing Company Navigating Geopolitical And End-Market Turbulence Quite Well

Taiwan Semi's Results Bring Some Relief, With Strong Demand For IoT And HPC

The global COVID-19 outbreak has made uncertainty the word of the moment, and the semiconductor space is no exception. Although data center spending remains strong, investors and analysts have fretted over the potential to hits to semiconductor demand in markets like consumer devices and autos. Based on Taiwan Semiconductor Manufacturing's ("TSMC") (NYSE:TSM) results and guidance, though, it looks like 2020 may yet hold up better than feared.

TSMC's short-term valuation has historically been driven by operating margins, which in turn are significantly influenced by capacity utilization. While today's valuation is not unreasonable relative to expected margins, I think you can argue that the modeling uncertainty calls for at least some margin of safety. I still think TSMC is a high-quality company, but without a wider margin of safety, there are other ideas in the chip space that I prefer today.

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Taiwan Semi's Results Bring Some Relief, With Strong Demand For IoT And HPC

Is This The Dip To Buy TSMC?

"Buy on the dips" is another one of those Wall Street sayings that gets repeated to the point of cliché. Unfortunately, it is never quite so easy. Dips are scary times to buy anything, because it goes against reason to buy when things seem to be getting worse. Besides, every abject failure starts as a "dip" and buying those stocks has a way of making the buyer feel like a "dip".

And yet, maybe this is one of those dips where investors should consider a stock like Taiwan Semiconductor (NYSE:TSM).

The Quarter That Was
Like a lot of the semiconductor companies it provides fabrication services for, TSM had a solid third quarter. Revenue rose 25% from last year and 7% on a sequential basis. Gross margin improved a bit, and operating income rose 35% from last year and 6% sequentially. Shipments were up 31% and 9%, respectively, and ASPs were down by a manageable low single-digit amount. 

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