TSMC: Riding Tailwinds In 2023 (NYSE:TSM)

We continue to be buy-rated on the Taiwan Semiconductor Manufacturing Company (NYSE:TSM). Our bullish sentiment on TSMC is based on our expectation that the company is better positioned to outperform now as the semiconductor space slowly but surely recovers and the company factors in the weaker demand for FY2023. TSMC’s 4Q22 earning results were mixed; the company beat estimates on earnings but came in low on sales. Despite this, the stock rose nearly 5% after reporting earnings. We believe TSMC is maneuvering dampened end-market demand and inventory corrections that have weakened sales and lower estimates for the next quarter. We expect TSMC and the semi-space will bottom in 1H23, followed by a sharp recovery in the second half of the year.

We believe that TSMC’s stock provides a favorable entry point into the bottom before the semi-space recovers. The stock is already up 41% since we last wrote on TSMC in late October, outperforming the SOX index, which is up only 21%. The following graph outlines our rating history on TSMC.

We recommend investors ignore the market noise around fears of a Chinese invasion of Taiwan and focus on an industry-first approach to the company. We believe TSMC is the best-positioned foundry player to benefit from chip demand once the semiconductor market recovers. On top of this, we believe the company will have the added power to increase ASP in the second half of 2023. We recommend investors buy the stock at current levels to enjoy TSMC’s upward growth trend in 2023.

Leading pure foundry space makes room for ASP increases

We like TSMC’s position within the foundry space, with a 60% market share in 4Q22, and expect this gives room for TSMC to increase ASP on advanced nodes. We believe TSMC’s market share saw significant growth in 2022 due to the increased output of smaller, more advanced 5nm wafers. Nanometer size is at the core of technological advancements for the semiconductor space and, by extension, the world as we know it. To clarify, nanometer size refers to the distance between the transistors on a chip; the smaller the chip, the more advanced and higher its performance. Our bullish sentiment on TSMC is based on our belief that the company’s growth will be driven by higher adoption of advanced nodes that are slowly making up more and more of TSMC’s revenue by technology. TSMC has also kick-started its production of 3nm chips for Apple (AAPL), upholding Moore’s Law and constantly looking toward next-generation technology.

The following graph outlines TSMC’s revenue by technology over the past several quarters.

We expect TSMC’s medium- to long-term growth to be driven by the increased global adoption of advanced nodes to feed the surging demand for semiconductors. Hence, we expect TSMC’s position enables it to increase ASP on advanced nodes in 2H23, mainly as it retains major semi-players as its top clients, including Nvidia (NVDA), Advanced Micro Devices (AMD), and AAPL, among others.

The following graph outlines TSMC’s increasing market share in the global semiconductor foundry market.

A dip in 1H23, followed by a sharp recovery in 2H23

TSMC is not immune to the demand slowdown caused by macroeconomic headwinds. TSMC’s chief executive C.C. Wei elaborated on this in Thursday’s earnings call, saying he expects 2023 to be “a slight growth year.” In 1H23, we believe TSMC will grapple with inventory corrections in response to the weaker chip-demand environment. We expect CAPEX cuts in TSMC during 2023, primarily as major client AAPL expects softer demand amid weaker consumer spending. TSMC management warned that revenue in 1Q23 would drop around 5%, and the annual investments would be slashed. TSMC reported CAPEX of $36.3B in 2022 and expects CAPEX for 2023 to decrease to $32-36B. We’re not too worried about TSMC’s lowered forecast for 1Q23 as we believe the company is de-risking guidance on the back of the rough macro environment.

Despite the macroeconomic headwinds, we expect TSMC to continue expanding its foundry presence outside Taiwan to derail any risks of geographically concentrating production in the contested Island. We’re constructive on TSMC playing a larger role in the global shift to manufacture chips in the U.S. after the CHIPS Act passed in 2022. The company has plans to more than triple its investment in the U.S. foundry plans to $40B making the U.S. a hub for advanced chip production by 2026. We believe it will be three to four years before the U.S. semiconductor Intel (INTC) and TSMC meaningfully produce chips on U.S. soil. Still, we believe U.S. fabs will be a long-term growth driver for TSMC.

Toward 2H23, we expect TSMC stock to rise on the back of the semiconductor industry’s recovery after a sharp pullback over the past 15 months. We expect the semiconductor space rebound to be boosted by product launches and increased production of 5nm wafers.

Valuation

We believe TSMC is a value stock; the company is relatively cheap, trading well below the peer group average. On a P/E basis, the stock is trading at 14.4x C2023 compared to the peer group average of 21.9x. The stock is trading at 0.2x EV/C2023 Sales versus the peer group average of 4.8x. We believe TSMC stock provides an attractive entry point at current levels and believe investors buying the stock at current levels will be well rewarded in 2023.

The following table outlines TSMC’s valuation alongside the peer group.

Word on Wall Street

Wall Street shares our bullish sentiment on TSMC. Of the 33 analysts covering the stock, 31 are buy-rated, and the remaining are hold-rated. The stock is currently priced at $500. The median sell-side price target is $590, while the mean is $611, with a potential upside of 18-22%.

The following tables outline TSMC’s sell-side ratings and price targets.

What to do with the stock

We continue to be bullish on TSMC. We believe the stock is reacting to weaker chip demand spilling into 2023. While we expect the stock price to remain volatile in 1H23 as the semiconductor space bottoms, we believe TSMC is well-positioned to enjoy demand tailwinds as the semi-space recovers in 2H23. We also expect TSMC’s growth to be driven by increased 5nm production and the company’s ability to increase ASP in 2H23 on advanced nodes. We believe the stock provides a favorable entry point at current levels and recommend investors buy the stock.