BING-JHEN HONG
Elevator Pitch
I rate Taiwan Semiconductor Manufacturing Company Limited’s (NYSE:TSM) stock as a Hold.
I previously wrote about Taiwan Semiconductor in an article published on April 28, 2022. In my prior update, I noted that it wasn’t a good time to be bullish on TSM at that time considering “sell-side expectations for the stock, the company’s growth outlook and valuations.”
Since the publication of my earlier article, TSM’s shares have fallen by -26.8% as compared to a -14.5% decline for the S&P 500 in the same period. Taking into account TSM’s stock price underperformance in the past few months, I assess if Taiwan Semiconductor is a potential investment candidate ahead of third-quarter earnings with my latest article.
Investors don’t have to worry about a Q3 2022 earnings miss for TSM. The company’s monthly revenue data releases and the depreciation of the New Taiwan dollar relative to the US dollar suggest that TSM should announce better-than-expected third-quarter earnings this week. On the flip side, a moderate pace of topline expansion and bottom line contraction in 2023 will cap TSM’s capital appreciation potential in the near term. In that respect, I think that Taiwan Semiconductor is deserving of a Hold rating.
TSM Stock Key Metrics
The key metrics that investors should analyze prior to doing a preview of TSM’s earnings are the company’s monthly revenue disclosures.
Taiwan Semiconductor announced on October 7, 2022 that the company’s topline expanded by +36.4% YoY to NT$208.25 billion in September 2022. But TSM’s September 2022 revenue represented a -4.5% contraction on a MoM (Month-on-Month) basis as compared to its August 2022 sales of NT$218.13 billion. As a point of reference, the company generated revenue of NT$186.76 billion for July 2022.
It is worth paying attention to the monthly revenue trends for TSM. The company’s YoY revenue growth has moderated from +58.7% in August 2022 to +36.4% in September this year. Also, Taiwan Semiconductor reversed from a +16.8% MoM increase in its topline for August this year to a -4.5% decline last month. In a nutshell, TSM appears to be losing revenue growth momentum.
More importantly, TSM’s actual total revenue for the third quarter of 2022 amounted to NT$613.14 billion, and this is slightly higher (+1%) than the sell-side’s consensus topline forecast of NT$606.18 billion as per S&P Capital IQ data. In USD terms, Taiwan Semiconductor’s Q3 2022 sales were $19.24 billion or +1% better than the market’s consensus revenue projection of $19.05 billion.
Given that TSM has met the market’s expectations with its Q3 2022 revenue, profitability holds the key to whether the company can achieve an earnings beat this week when its third-quarter results are announced. I touch on Taiwan Semiconductor’s profitability expectations and its chances of an earnings beat for Q3 2022 in the next section.
Is Taiwan Semiconductor Expected To Beat Earnings?
I expect Taiwan Semiconductor to beat investor expectations, when the company reports its financial results for the third quarter of 2022 on Thursday, October 13, 2022.
The sell-side analysts see TSM’s normalized earnings per share, or EPS, growing by +57.7% YoY to $1.69 in Q3 2022. Based on financial data taken from S&P Capital IQ, the sell-side’s consensus third-quarter gross profit margin projection for Taiwan Semiconductor is 59.03%. This is in line with TSM’s Q3 2022 gross margin guidance of between 57.5% and 59.5% outlined at its earlier Q2 2022 earnings call in mid-July 2022.
My bet is on TSM achieving a higher-than-expected gross margin for Q3 2022, which will drive an earnings beat for the company. I estimate that Taiwan Semiconductor’s actual Q3 2022 gross margin should be above 60%. The USD-NT$ exchange rate has gone from 29.67 as of June 30, 2022 to 31.82 as of September 30, 2022, the depreciation of the New Taiwan dollar relative to the US dollar has a positive impact on Taiwan Semiconductor’s gross margin.
As a comparison, TSM’s actual Q2 2022 gross margin beat its initial management guidance by +0.9 percentage points because of “a more favorable foreign exchange rate” as highlighted by the company at its second-quarter investor briefing.
Even though TSM is expected to deliver a positive earnings surprise this week based on my analysis and it achieved earnings beats for both Q1 2022 and Q2 2022, the company’s shares have been performing poorly in 2022. In the subsequent section, I discuss what might have contributed to Taiwan Semiconductor’s share price weakness this year.
Why Has TSM’s Stock Price Been Dropping?
Year-to-date, Taiwan Semiconductor’s stock price fell by -47.6% and its shares have underperformed the broader market. In 2022 thus far, the S&P 500 has pulled back a relatively milder -24.7%.
Investors are looking forward and turning their attention to how TSM might perform in 2023, rather than focusing on the company’s near-term financial results.
In the last three months, the fiscal 2023 consensus revenue and normalized EPS forecasts for TSM have been cut by -6.5% and -4.0%, respectively. In USD terms, Taiwan Semiconductor’s topline expansion on a YoY basis is expected to slow from +22.7% in fiscal 2022 to +9.9% for fiscal 2023 as per consensus financial projections. Similarly, TSM is forecasted by analysts to reverse from a +50.6% YoY increase in its bottom line for FY 2022 to a -1.5% EPS contraction in FY 2023 in USD terms.
Inventory issues and the pace of price increases are the key factors that have led analysts to have a pessimistic view of TSM’s 2023 prospects.
At its Q2 2022 earnings briefing, TSM noted its expectations that “the excess inventory in the semiconductor supply chain” points to “a few quarters of inventory adjustment likely through first half 2023.” This will hurt TSM’s revenue next year.
Also, the sell-side analysts forecast that TSM’s gross margin will rise from 51.6% in FY 2021 to 58.1% in FY 2022 prior to declining to 54.4% for FY 2023 as per consensus numbers taken from S&P Capital IQ. Taiwan Semiconductor is unlikely to be able to raise its selling prices in 2023 to the same extent as it did in 2022 which was what drove its gross margin expansion this year. Notably, TSM emphasized at the company’s second-quarter investor call that “our pricing is strategic and value-driven, not opportunistic or cost plus” and stressed that its long-term gross margin target is “53% and higher.” It is reasonable to assume that TSM will either initiate fewer price hikes or have price increases of a lesser degree in 2023.
In summary, the expectations of revenue slowdown and earnings decline next year are what depressed TSM’s share price in 2022 year-to-date.
What Is The Target Price For TSM Stock?
My price target for TSM’s shares is $73.30, which translates into a +9% upside as compared to the company’s last traded share price of $67.44 as of October 10, 2022.
I have arrived at my target price for Taiwan Semiconductor by applying a forward P/E multiple of 12 times to its fiscal 2023 consensus EPS of $6.11. According to S&P Capital IQ’s valuation data, TSM has traded as low as 10 times forward P/E in the past 15 years. As such a forward P/E valuation multiple of 12 times is fair considering expectations of a semiconductor downcycle.
The potential capital appreciation upside of +9% (below the 15% required rate of return needed for a Buy) as implied by my price target supports a Hold rating for TSM’s stock.
Is Taiwan Semiconductor A Good Long-Term Pick?
I do consider Taiwan Semiconductor as a good long-term pick.
In the long run, TSM will continue to be a beneficiary of strong chip demand driven by trends like artificial intelligence, electric vehicles, 5G, cloud computing among others. Separately, Taiwan Semiconductor s currently valued by the market at 11 times consensus forward next twelve months’ P/E and this is close to its 15-year historical trough P/E multiple of around 10 times. While there is the risk that TSM’s future earnings turn out to be even lower, further multiple de-rating should be limited to some degree.
But it is way too early to turn bullish on TSM, as 2023 will be a tough year for Taiwan Semiconductor and there are no visible catalysts in sight.
Is TSM Stock A Buy, Sell, Or Hold?
TSM’s stock warrants a Hold rating. Taking into account both the prospects of a Q3 2022 earnings beat and expectations of weaker financial results for FY 2023, I have decided that a Hold investment rating for TSM is the most appropriate.
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