Rather than designing its own chips, Taiwan Semiconductor Manufacturing (TSM) pioneered the dedicated fabrication business model. This approach proved to be a great fit for the industry, and essentially led to a paradigm shift that saw many semiconductor companies move away from having their own fabrication facilities. Those businesses still design their own chips, but now, they rely on TSMC (and its smaller peers) to manufacture them.
Through its technology and infrastructure advantages, the fab giant is able to leverage economies of scale and deliver superior value for its customers. By some estimates, TSMC has captured roughly 55% of the market for contract chip manufacturing and more than 90% of the contract fab market for advanced semiconductors.
High-performance chips have never been more essential for the technology, industrial, and defense sectors, and they will only become more crucial. Depending on how you look at it, it wouldn’t be a stretch to say that TSMC is the most important company in the world.
Strong business performance and a promising growth outlook
Since it went public in 1994, TSMC has increased its revenue at an 18% compound annual rate and its earnings at an 18.6% rate. Despite being a much larger business today, management anticipates it will grow its revenue at an annualized rate of between 15% and 20% from 2021 through 2026. Across that stretch, it also expects its gross margin to be higher than 53% and its return on equity to be above 25%.
The chip fabrication giant’s revenue climbed 26.7% year over year to reach $19.93 billion in 2022’s fourth quarter, and the business recorded a net profit margin of 47.3%. Across 2023’s first two months, the business grew sales by 13.8% even in the face of macroeconomic headwinds.
Sales growth will likely continue to decelerate as the year progresses due to cyclical shifts and macroeconomic pressures. TSMC also anticipates some margin contraction this year due to semiconductor cyclicality, inflation, and other factors, but it still anticipates posting an operating income margin in the range of 41.5% to 43.5% in the first quarter.
While 2023 will likely be a year of relatively slow sales growth for TSMC, some industry insiders and analysts are expecting a return to much stronger demand in 2024, and the long-term outlook remains promising. Semiconductor equipment manufacturer ASML, which has TSMC as its largest customer, expects global semiconductor sales will expand at a 9% compound annual rate from 2020 through 2030. Driven by expanding applications and industry innovations, growth is expected across virtually all semiconductor markets.
One key risk factor TSMC investors are watching
Concerns that China could move to increase its control over Taiwan through military action or other means have contributed to the bearish sentiment around TSMC. The U.S.’s move to block the export of certain high-end artificial intelligence chips and semiconductor-manufacturing equipment to China has also raised investors’ concerns. In the face of these challenges and broader macroeconomic pressures that have worked to depress valuations for tech stocks, TSMC stock is down roughly 37% from its peak.
The fab leader looks like a smart long-term buy
The importance of TSMC on the world stage factors into the current geopolitical tensions surrounding Taiwan, but any attempt to gain control of the company militarily would likely result in the destruction of its factories. While it’s impossible to say how the situation and relations between the U.S. and China will progress, the likelihood that TSMC’s factories would be destroyed in the event of military actions in Taiwan seems like a strong deterrent against attempts to gain control of its resources.
While geopolitical uncertainty represents a significant risk factor, TSMC is also on track to benefit from support from various national governments. President Joe Biden’s CHIPS and Science Act, which he signed into law last August, includes $39 billion in funding for the construction of new chip manufacturing facilities in the U.S., and it is at least partially geared toward helping TSMC advance its stateside operations.
And for long-term investors, valuation pullbacks occurring despite great business performance present a worthwhile buying opportunity.
With the stock trading at roughly 15.5 times expected 2023 earnings, TSMC looks attractively valued given its strong competitive position and the favorable industry growth trends. Income-seeking investors have another reason to like the stock. The company has been paying dividends since 2004 and has never lowered its payout across that stretch. At the current share price, TSMC’s dividend yields roughly 2%.
Between its powerful competitive strengths and its attractive valuation, Taiwan Semiconductor Manufacturing stands out as a top pick-and-shovel play for investors who would like to benefit from the growth of the chip industry and the tech sector at large.
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Source: The Motley Fool