If you can only invest in ten companies in the next ten years, TSMC (TSM.US) will undoubtedly be an investment target that cannot be ignored.
Although the stock is currently being sold off due to concerns about an economic recession and its possible slowdown in growth, in the opinion of SeekingAlpha contributor WideAlpha, TSMC is one of the most attractive companies in the world today. "We are not overly concerned about the sell-off as we believe the stock has fallen out of the market's pricing for slower growth," WideAlpha noted.
Historically, because foundries tend to add excess production capacity during economic booms, they have obvious cyclicality due to insufficient capacity utilization during economic downturns. This also results in its profit margins being greatly reduced, and it may even suffer losses at times.
But overall, investors don’t need to worry too much about TSMC because the company makes most of its profits from its advanced nodes and is one of only two foundries in the world with the most advanced technology. Older node foundries that focus on the more commercial side are the ones to worry about. Second, TSMC has a large customer list waiting for orders, and these customers are likely to offset much of the potential demand decline due to the recession. Finally, most of its competitors are limited to low-end manufacturing due to the high costs and engineering associated with cutting-edge technologies.
Competitive Advantages
TSMC’s moats come from multiple sources, including patents and trade secrets required for advanced nodes. However, that's not all, as the company is also a very efficient manufacturer, two factors that make TSMC a low-cost producer of high-tech chips.
In addition, being able to produce advanced nodes brings other advantages, including improving the energy efficiency of customer end products.
A less obvious advantage is that TSMC also benefits from its effective scale dynamics. A market of efficient scale is one or a few companies that provide effective services. Existing manufacturers in the market can obtain economic profits, but potential competitors do not have incentives to enter the market. Once a company has made the significant investments necessary to develop these assets, there is little point in other companies trying to compete with them.
Financials
The strength of its competitive advantage is also reflected in the significantly above-average profit margins that TSMC has maintained over the past decade. Globally, few companies have operating profit margins above 40%, and those that do usually have strong competitiveness.
In turn, a competitive moat provides the company with an attractive return on investment. For example, TSMC's return on invested capital (ROIC) has averaged about 21% over the past ten years, and has continued to rise to about 24% recently. TSMC is not an asset-light company as it requires billions of dollars of investment. This brings its business closer to the ideal of being able to absorb large amounts of capital and still deliver very high rates of return.
Growth Prospects
Another feature that makes TSMC an advantageous company is its high growth. The company's revenue has grown by an average of about 16% over the past decade. While the company is relatively cyclical, overall its revenue averages remain high, and even the average in recent quarters (about 36%) is above its long-term average.
Additionally, in past cycles, most semiconductor demand came from PCs and mobile devices, but this has now expanded to include high-performance computing, automotive, IoT and other smaller market segments. This expansion should help moderate cyclicality, as strength in one sector helps offset weakness in another. Applications such as machine learning and artificial intelligence are also growing particularly fast, and these areas tend to use GPU/TPU manufactured by the most advanced nodes. Because of this, TSMC's advantages can be fully reflected in the two most advanced nodes, 5nm and 7nm, which account for about half of its total revenue.
stock valuation
From the above analysis of enterprise value, we can see that the company's business quality is very high, but the stock price has fallen sharply recently. In the view of WideAlpha, this will undoubtedly make the stock valuation more attractive.Currently, the stock's stock price is only about 10 times enterprise value/ earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), close to the average of 9.7 times over the past ten years, and forward EV/EBITDA is only about 8.7 times.
The stock's current price-to-earnings ratio (about 18.5 times) is also below its ten-year average of about 19 times, and its forward price-to-earnings ratio is only about 14.7 times. Considering the impressive profits, growth, ROIC, etc. generated by the company's business, this valuation is quite cheap.
In addition, it can also be seen from the calculation results of the discounted cash flow model that the stock is undervalued. Over the past decade, the company's profits have grown an average of 21%. If we take a conservative estimate, using a simple discounted cash flow model over the first three years using analysts' average expected earnings and assuming a growth rate of 10.5% over the next seven years (half of the company's previous ten years), the company The final growth rate will be 5%, and using a 10% discount rate, the stock's net present value per share will be $179, or more than double its current trading price. This suggests that if the company can continue to achieve at least half of its historical growth rate, the share price could be said to be undervalued.
Performance guidance
TSMC’s performance guidance for the second quarter of 2022 also released an optimistic signal. The company currently expects revenue to be between $17.6 billion and $18.2 billion; gross margin is expected to be between 56% and 58%, and operating profit margin will be between 45% and 47%.
Risks
Finally, if we want to talk about risks, WideAlpha believes that the main risk of long-term investment in TSMC is that if competitors are able to surpass TSMC in semiconductor node development, the company's technology will become obsolete. So far, though, the company has done a good job of staying ahead of the curve, investing heavily in R&D to ensure competitors can't catch up to them. In fact, the company has been reinvesting about 8% of its revenue in research and development.
Conclusion
Overall, WideAlpha believes that TSMC is one of the most attractive companies in the world and one of the few companies with operating profit margins exceeding 40%. TSMC's competitive moat is massive, allowing it to achieve excellent returns on investment and grow at a very high rate. As a result, WideAlpha estimates that the stock's fair value will be $179.
