TSMC: One chipmaker that has serious potential to outperform its peers

• TSMC capped off 2021 with a record USD 56 billion in revenue – 25% higher than the year before as all six platforms experienced positive growth. 

• The company has budgeted up to USD 44 billion in capex this year, most of which will be used to develop advanced technologies, where demand remains robust. 

• Given its focus on advanced technologies, TSMC is in a much better position to weather any future slowdowns compared to its smaller peers. 

• Based on a fair PE multiple of 24X, we arrive at a target price of USD 148 for TSMC. This implies an upside potential of close to 25% based on its last traded price of USD 119.84 (as of 3 Feb 2022).

TSMC (NYSE:TSM) capped off 2021 in spectacular fashion. Thanks to the growing demand for semiconductors, the world’s largest chipmaker delivered record high revenues of USD 56.8 billion, 25% higher than the year before (Figure 1). Earnings per share (EPS) came in at USD 0.82, representing a year-on-year increase of 23%, in line with consensus forecast. 

While TSMC is no stranger to posting strong results, last year’s growth is considered good even by the company’s standards. 

Figure 1: TSMC capped off 2021 with revenue at an all-time high

In 2021, all six platforms achieved positive growth, demonstrating how increasingly tech driven almost every sector of the global economy has become. Among the six platforms, automotive saw the strongest growth at 51% year-on-year, followed by high performance computing (HPC) and internet-of-things (IoT) at 34% and 21% respectively (Figure 2).  

The auto sector, which has been plagued by a shortage of chips over the past two years, saw several rounds of price hikes as car manufacturers scrambled to keep up with the rising demand for vehicles. The result is higher-than-normal revenue growth for many auto chipmakers, including TSMC. 

In terms of technology, advanced technologies (defined as 7nm and below) accounted for approximately half of TSMC’s revenue (Figure 2). In a field where technology leadership is vital, the key to success is to possess the best possible technology, something that TSMC has mastered throughout the years with its rigorous R&D program. 

Figure 2: TSMC is one of the few foundries in the world that generates the majority of its revenue from advanced technologies 

Healthy demand for advanced technologies benefits TSMC

To maintain its technology leadership and meet the ever-increasing demands of its customers, TSMC announced that it will be raising its capex budget to between USD 40-44 billion in 2022, 40% more than what the company spent in 2021. 

Of the total amount, 70-80% will be used to develop advanced technologies, including TSMC’s industry leading N3 node that is scheduled to begin volume production in 2H22. The company also shared that it has already received multiple tape-outs for its N3 node, and expects the total number of tape-outs for N3 to exceed those received for N5 for the first year. 

These days, an increasing number tech giants are choosing to design their own chips instead of buying them off the shelf. Back in November 2020, Apple – the fourth largest PC vendor by shipments – announced that it will stop relying on Intel’s (NASDAQ:INTC) processors for its Macbooks, and design them in-house instead.

More recently, cloud service providers Amazon (NASDAQ:AMZN) and Alibaba (NYSE:BABA) both launched new server chips which have been designed in-house, marking a major shift in the semiconductor industry. By designing their own chips, these companies are able to differentiate themselves from their competitors and build chips that better fit their requirements. 

While the news of more tech giants designing their own chips may be bad news for fabless chipmakers, TSMC stands to benefit as it is one of the few leading pure-play foundries.

TSMC likely to be more resilient than its peers in a slowdown

At this juncture, there is a possibility that the semiconductor industry may see a slowdown in the near future. The shortage that we are experiencing today could turn into a glut in the months ahead if demand falters or if capacity expansion plans are not managed carefully. 

However, given that the current shortage mainly affects the mature nodes, and to a lesser extent, the leading edge nodes, we think that TSMC should not be as badly affected as its smaller peers in the event of a correction.  

Moreover, the company disclosed that it has been receiving more prepayments from its customers to retain capacity. Not only do prepayments lower the probability of order cancellations in the future, it also helps to mitigate the financial impact should they occur. 

TSMC received prepayments totalling USD 6.7 billion last year, which is roughly equivalent to 12% of its revenues. The management has also said that they expect prepayments to be even higher this year as customers look towards TSMC to secure their supply of leading edge chips. That said, we think that TSMC is better positioned to weather a slowdown compared to most of its peers.  

Related Article: Semiconductors: Chip drought? It’s time to start worrying about a chip glut

Even if a down-cycle does occur, the impact is likely to be softer than before. Over the years the semiconductor industry has seen some dramatic changes, with the range of end-use products expanding rapidly. 

In the past, the semiconductor cycle was mainly driven by changes in personal computer (PC) demand, given that it was the dominant end-use market at the time. Fast forward to today, the widespread proliferation of semiconductors in modern electronics has created a multitude of end-use products, such as internet-of-things (IOT) devices and electric vehicles. 

As the range of end-use products continues to widen, the overall demand for semiconductors should become more stable, resulting in milder down-cycles than before, as can be observed from the magnitude of the changes in sales growth (Figure 3). 

Figure 3: The decline in sales growth over the past few down cycles is noticeably smaller versus a decade ago

While there may be ups and downs in the near-term, we believe that the long-term outlook of the semiconductor industry remains overwhelmingly positive. With digital transformation accelerating, we should expect to see an increase in the structural demand for semiconductors, underpinned by megatrends such as 5G and HPC applications. In addition, the higher silicon content of these applications will also contribute to the structural increase in demand for semiconductors.

Growth potential of TSMC should exceed the overall chip industry 

As one of the few foundries capable of producing leading edge chips, customers really do not have much of a choice if they are seeking the latest technology. Decades of R&D has paid off as TSMC’s technology leadership has turned into an unassailable moat, which basically guarantees the company’s future growth. 

As a matter of fact, the management projects that for 2022, TSMC should be able to outperform the overall semiconductor industry by a comfortable margin. This is also likely to be the case in the years to come. 

Taking into account TSMC’s competitive advantage, we believe that a distinction has to be made between TSMC and the overall semiconductor industry. Therefore, we have decided to raise our fair PE multiple to 24X, from the previously established 22X (our fair PE for the industry remains at 20X).

Applying this multiple to the estimated EPS per ADR of USD 6.18 for 2023, we arrive at a target price of USD 148. This implies an upside potential of close to 25% based on TSMC’s last traded price of USD 119.84 (as of 3 Feb 2022).

Table 1: Earnings growth to remain resilient 

Figure 4: In the long-run, share prices are predominantly driven by earnings

While the broader industry may start to face some supply side pressures as the shortages eases, TSMC should not be significantly affected given its focus on advanced technologies, which are almost always in demand. 

Having secured a dominant position within the industry, we are confident that even if a slowdown does occur, TSMC’s resilience will enable it to outperform its peers.