Johnny Greig
Introduction
The recent volatility in the semiconductor sector is a boon for people like me who are looking to add one of the industry's hottest companies to their portfolios and perhaps thought it might have been Too late, Taiwan Semiconductor Manufacturing Company Limited (New York Stock Exchange: TSM)I am going to discuss some of the key catalysts that will help the company reach its potential in the coming years as I believe the company is still flying under the radar of many investors and is undervalued. The company is a picket trader of the modern gold rush, which is AI.
Since I last talked about TSM, volatility has reduced its valuation to around 15%, meaning the company is even more attractive than it was back then. I analyzed why the company's price rose so much, and in this article, I will dwell on it. We explain in more detail why TSM is a very good long-term bet.
For now everything revolves around AI
Without AI, companies like NVIDIA Corporation (NVDA) would have been very little known in a broader sense. Jensen Huang would have been relatively unknown. A CEO of a graphics card company that received some sort of press attention before AI was the go-to for bitcoin mining. Before AI and bitcoin mining, the company was known among gaming enthusiasts who were building their PC rigs to be able to run Crysis with a more or less decent frame rate. That has all changed in just a couple of years. The company has been hard at work on its chips that powered the AI revolution, the modern gold rush so to speak, and certainly many benefited, especially NVDA.
But without TSMC and its expertise in manufacturing the specific designs of NVDA chips, I find it hard to imagine what that world would look like. Had TSMC not existed, would Intel Corporation (INTC) have been the choice for the chip manufacturing process? There has been a lot of talk lately about the demand for AI chips. Some analysts say that demand will soften in the near future, which will hurt NVDA and therefore TSMC’s numbers in the coming quarters. So, is that it? Is the AI revolution over? In July, TSMC reported what I consider to be excellent results – compared to previous quarters where revenue growth failed to even reach +10%, or was even negative, a 33% YoY increase for the last quarter is a huge turnaround, reflecting that demand for AI chips is alive and well. Moreover, the company went ahead and raised its outlook due to strong AI demand. I was surprised that we didn't see a significant increase that day, but because the markets were choppy at the time, people were cautious. In July, TSMC's sales were reported to have increased by 45%, showing that further acceleration is coming.
And AI's darling, NVDA, last week reported quarterly results that beat estimates and, very comfortably I might add, says that “Demand for hoppers remains strong and the anticipation for Blackwell is incredible.” NVDA was down that day, but I don't know what people expected the company to do. NVDA is perfectly priced, so the only way it would go up was if it beat estimates by an even bigger margin.
In addition, big tech companies are not considering cutting R&D spending on AI and A recent survey shows that many companies (90% of respondents) are considering boosting AI-related R&D and capital expenditure by 2025. Just look at the chart below of the tech industry giants and how their capital expenditure has progressed in recent years, thanks to increased investments in AI.
Reuters
So tell me where is the slowdown?
Factory expansion and diversification efforts
Now, to meet that AI demand, TSMC is expanding its presence around the world. Three fabs are being built in Arizona to meet demand and cement its leadership in the semiconductor industry. The last of the fabs will incorporate the latest 3nm and 2nm technology and begin production in 2028. I think it’s safe to say that TSMC will continue to benefit from CHIPS Act grants and subsidies, just like Intel, but seeing as TSMC has the most advanced technology out there, the US will certainly want to have that capability on its home turf, away from China’s hands.
TSMC isn’t stopping there, with the massive funds it has at hand, it is looking for more expansion opportunities outside of Taiwan and the US. The company is also taking advantage of the European Chip Act. The company’s recent partnership with Robert Bosch, NXP Semiconductors NV (NXPI), and Infineon Technologies, of which TSMC owns 70%, received a €5 billion German aid for the chip plant in the city of Dresden, Germany. The plant won’t be built for AI demand, but that only helps the company further diversify its offering for when AI demand starts to wane. This plant will start operating sometime in 2029, so don’t expect revenues in the near future. This opens up the possibility of further investments under the European Chip Act in other regions of the EU, and I wouldn’t rule that out.
Factories in Japan are another key strategy to diversify beyond Taiwan and consolidate its presence around the world, which should ease fears of a Chinese invasion of the island. The company hopes to ship logic chips for camera and car sensors for the end of this year. This takes us even further away from the risks of an AI slowdown in the future, something I'm sure will be inevitable at some point.
Price increases are finally confirmed
I have been thinking for many months now why TSMC has not leveraged its position with all these AI pioneers a bit more. The company, in my opinion, has all the leverage in the world when it comes to raising prices. It has the technology that makes NVDA make billions of dollars every quarter. So, when the company finally hinted at possible price increases soon, I was hopeful, however, now that it has finally been confirmed to happen in 2025, I feel like they missed a much bigger opportunity. A 3% to 8% increase is not enough in my opinion. The management team is too nice and didn’t want to step on anyone’s toes by the looks of it, but when you have that much power, why not be greedy like the rest of the AI players? At least maybe this way, the company will keep raising prices every year and over time, it will end up being a decent boost to their revenue. I am sure that will be the case in the future. And how will NVDA cope with this minuscule increase in production costs? They will likely pass it on to the big tech companies while continuing to increase their capital expenditure. The increase will go directly to improving the company's margins.
In short, there is a lot of room for a company to continue to perform well. Many of the company's projects won't be operational for at least 3-5 years, so I'm confident in holding the company for the long term. The strong demand for AI is still there, though, so enjoy it while it lasts because we don't know when things will turn around, but I'm confident in TSMC's diversified offering, so even if AI dries up, it won't lose much of its revenue in the long run.
Risks for the thesis
Of course, there are things to worry about in the short term that will affect the company's valuation.
First, the volatility of the semiconductor market and frothy valuations do not paint a good picture. While I think TSMC is undervalued compared to many other semiconductor companies, that does not mean that its stock price will not be affected. NVDA will have to perform miracles over the next year or so to justify its market cap of almost $3 trillion. In my opinion, that is a tall order. Any significant weakness in the next few quarters or failure to beat expectations enough will send the company's stock tumbling, as it did last week. There was a time when semiconductor stocks were in negative sentiment. Just a year ago, nobody liked them and TSMC was trading at a price-to-earnings ratio of around 12. In my opinion, it was a no-brainer buy. Now that its P/E ratio has almost doubled, it is not as cheap as it once was, but I think the outlook is very positive and the P/E ratio of 25 over the last 12 months is decent.
Secondly, and this is a longer-term risk, the AI downfall is coming, there is no doubt about it. Big tech companies will start to reduce capital spending over time, especially if all that capital pumped into AI doesn’t produce revenue or significantly improve their bottom line. The big risk here is that all that money spent will be for nothing. missing income It is a real risk.
Finally, the obligatory geopolitical risks are still present. The latest quarterly report showed that the company gets 16% of its sales from China, which is the highest level in a long time. This will deter many investors who are not fond of such risks and do not want to have anything to do with China. Further restrictions on China may affect TSMC's top line, but in my opinion, even with such a percentage coming from China, not all of that revenue will be lost. Especially with the diversification efforts the company has been making, the China risk should significantly decrease in the coming years.
There has been a lot of talk lately about a recession coming. History may not repeat itself, but when it does, The Federal Reserve changes its stance Markets tend to perform poorly over the next year or so. With massive revisions to the Employment data is flowingThe highest level we've seen since 2009, it's hard not to make comparisons. Would you be very surprised if a year from now we found out we were already in a recession? I wouldn't be surprised.
Final comments
These are the reasons to stay calm in such turbulent times and to continue holding and buying more on significant dips, such as the one we saw recently. The company’s roadmap looks very promising, which solidifies my long-term outlook. I still believe that many investors fail to recognize the true potential of the company and how central it is to many technologies out there, not just AI, which is the focus right now. AI has arrived and will likely be replaced by another advanced technology; if TSMC wants to remain the key leader in the industry, it will most likely be selling the picks for the next modern gold revolution and reaping the rewards for decades to come.
My fair value of $222 per share is still in place and I won't be selling once I hit it. I'm sticking with the same valuation because the last quarter didn't impact my already conservative estimates. With a price drop, we're looking at a 37% increase from fair price. Why would I sell a company that continues to improve over time?
In the short term, I could see the stock price continuing to decline, especially if the global economy falls into a recession soon, but I will be prepared with open arms and plenty of dry powder to take advantage of.
Volatility in the markets will likely present even better entry opportunities over the longer term, but I will continue to average down until something drastic changes in the company's operations, but for now, the company remains a strong buy in my opinion.