How Big Can Taiwan Semiconductor Get?

Taiwan Semiconductor (TSM) sales are roughly equivalent to the GDP of Panama.

Yeah…it’s massive.

The company owns over half of the global foundry market, with Samsung coming in a distant second at 18%.

By market cap, it’s the second largest semiconductor company behind Nvidia (NVDA).

By manufacturing capacity, it’s second only to Samsung.

Despite its size, Taiwan Semiconductor reported blowout earnings last week, sending the stock up almost 10%.

Yet, financial pro search volume continued to focus on Nvidia.

We will cover them once they report earnings.

But for today’s issue, we wanted to take a look at Taiwan Semiconductor and see how much further this stock could run.

Taiwan Semiconductor’s Business

To set the stage, let’s discuss how the semiconductor industry works.

First you have the design, which is a focus of Advanced Micro Devices (AMD) and Nvidia. 

Those designs get sent to a foundry for manufacturing, which is where Taiwan Semiconductor plays.

Intel (INTC) does design and manufacturing.

Taiwan Semiconductor does just manufacturing, taking orders from companies like AMD and turning them into a reality.

Many companies shy away from the manufacturing end because it requires heavy capital investment and can fluctuate between boom and bust cycles.

Yet, Taiwan Semiconductor continues to do extremely well as demand for AI chips continues to soar along with the smartphone industry.

In fact, these two industries account for 86% of the company’s 4th quarter revenues:

Source: TSM 2023 Q4 Investor Presentation

After a boom in sales post-COVID, 2023 brought quarterly revenue declines as the business normalized.

However, management expects growth to return as AI demand heats up in 2024.

Financials

Source: Stock Analysis

Taiwan Semiconductor has seen sales jump yearly for the past decade… until this year.

Nonetheless, margins are at their highest levels across the board, with free cash flow being the only exception.

Capex exploded to $30-$35 billion starting in 2021, double what it was in 2020 and 350% higher than in 2018.

Management invested heavily in the 3-nanometer chips demanded by Apple and other smartphone providers as well as the AI industry.

That spend should have peaked in 2023 and begin to decline gradually as production ramps, further improving the company’s performance.

While $8.8 billion in dividends exceeded the $2.7 billion in free cash flow, that should turn around in 2024 to results similar to 2022 when free cash flow exceeded $9.2 billion.

Valuation

Source: Seeking Alpha

Despite the surge in the company’s stock price, valuations are still quite reasonable.

Taiwan Semiconductor trades at just 17.8x forward earnings compared to Nvidia at 51.1x.

And Taiwan Semiconductor’s price-to-cash flow of 11.7x is cheaper than perpetual loser Intel (INTC).

Growth

Source: Seeking Alpha

2023 was a rough sales comp year for all processor companies…except Nvidia.

While Taiwan Semiconductor won’t hit the same growth figures as Nvidia, its 10% forecast is respectable, coupled with an average sales growth of +15% over the past 3-5 years, something only AMD has matched.

Profitability

Source: Seeking Alpha

We were surprised to see Taiwan Semiconductor’s gross margins exceed AMD’s, given AMD is a design-only company.

Then again, Taiwan Semiconductor is the best at what they do, with a net income margin of 41.4%, just behind Nvidia.

Our Opinion 10/10

While Intel is gunning for Taiwan Semiconductor’s foundry business, they’ve shown no signs of being able to execute.

Yes, there’s always the geopolitical risk from China. But we see that is minimal.

Taiwan Semiconductor delivers consistent results despite its size.

While it’s up a decent amount, we believe it can double from here over the next 3-5 years.