Image Credits: TSMC
• After going on a cyclical upswing over the past two years, the semiconductor industry will likely enter into a down cycle over the next few quarters as demand falters.
• Because of its technology leadership, we believe that TSMC will be more resilient than its peers. The use of long-term contracts also helps mitigate any negative financial impact to the company in a downturn.
• We continue to remain positive on the long-term growth prospects of the semiconductor industry and TSMC, and expect demand to exceed previous levels when the recovery begins.
• Our target price for TSMC is USD 135. This translates to an upside potential of approximately 60%.
Semiconductor industry will likely enter a down cycle
After going on a cyclical upswing over the past two years, the semiconductor industry is starting to lose steam, and is likely to enter a down cycle over the next few quarters. Sales growth has been falling rapidly, and is now at 18% for 2Q22 versus a peak of 30% back in 3Q21 (Figure 1). Lead times have been basically unchanged over the past three months, a sign that the pandemic-driven surge in demand is coming to an end.
Figure 1: The semiconductor industry is on a cusp of a down cycle
With inflation looking to stay higher for longer, the Fed has adopted an aggressive rate hike policy, raising rates by 225 bps in a span of four months. As a result of these factors, consumers who have been feeling the pinch from tighter financial conditions are starting to cut back on discretionary purchases, such as smartphones and PCs. This has in turn reduced the demand for chips.
In light of the deteriorating outlook, the share prices of chipmakers have not been doing well, shedding more than -32% on aggregate since the beginning of the year.
Related Article: Semiconductors: Maintain 2.5 Stars “Neutral” as we await a better entry point
Why TSMC will still be a winner in the face of a downturn
Despite the dreary near-term outlook of the chipmaking industry, not all companies will be affected by this downturn equally. Among the various players, one company stands above the rest. It is none other than Taiwan Semiconductor Manufacturing Company (NYSE:TSM).
Related Article: TSMC: One chipmaker that has serious potential to outperform its peers
TSMC reported a strong set of results for 2Q22, with revenue rising by 43.5% year-over-year. Meanwhile, earnings per share (EPS) rose by 76.4%, partly due to more favourable exchange rates and cost improvements. Although overall demand in the near-term is expected to be weaker than before as the industry goes through a down cycle, TSMC still expects its capacity utilisation rate to stay healthy over the next two years. In addition, the management has reiterated that long-term revenue growth should be in the range of 15% to 20% - a projection which we think is achievable, or even overly conservative.
Here are a few reasons why.
Firstly, there has been a structural increase in the demand for semiconductors over the years. These days, the use of semiconductors are not only limited to PCs - almost every product has them. With the world becoming increasingly digitalised, the number of semiconductor applications will only continue to increase.
Besides the wider range of end use products, the silicon content in most products has also increased significantly over the years. Take cars for instance. Thanks to new innovations such as autonomous driving, the silicon content of cars today is estimated to have grown by more than five times compared to a decade ago, and it is still expected to grow even further (Figure 2).
Figure 2: Intel’s CEO predicts that chips will make up more than 20% of a vehicle’s total cost by 2026
Source: Intel
TSMC, the company at the forefront of semiconductor technology, is well-positioned to take advantage of this trend. Thanks to its technology leadership, TSMC has effectively cemented its place as the number one go-to foundry for customers looking to get their hands on the most advanced chips available. The company has a market share of 53% and has a client list that features high profile names, including the likes of Apple (NASDAQ:AAPL) and AMD (NASDAQ:AMD).
Due to the fact that only a handful of companies are able to fabricate advanced semiconductors, supply is extremely limited. As such, customers usually enter into long-term agreements in order to retain capacity. These contracts are typically non-cancellable and often require prepayments, helping to mitigate any negative financial impact to the company in the event of a downturn. This could be the reason why TSMC has managed to maintain strong sales numbers up till today. The company saw revenues in July surge 50% to TWD 186 billion, an all-time high.
To sum things up, even though a down cycle looks more or less inevitable, we believe that that TSMC’s technology leadership places it in a strong position to weather this storm and emerge stronger when things blow over. Furthermore, valuations of the company remain undemanding as it is currently trading at just 14X 2024 estimated earnings. Our target price for TSMC is USD 135. This translates to an upside potential of approximately 60% (Table 1).
Last but not least, we would like to remind investors again that down cycles are temporary, and investors should have nothing to worry about as semiconductor demand will likely rise to higher levels than before when the recovery begins.
Table 1: Despite the down cycle, TSMC is expected to outperform the broader semiconductor industry
|
2021 |
2022E |
2023E |
2024E |
|
|
EPS per ADR (USD) |
4.12 |
4.41 |
4.72 |
6.13 |
|
EPS Growth |
23.8% |
7.0% |
7.0% |
30.0% |
|
PE Ratio |
29.20 |
18.91 |
17.67 |
13.59 |
|
Upside Potential |
- |
- |
- |
61.85% |
|
Source: Bloomberg Finance L.P., iFAST Estimates |
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