Warren Buffett Thinks TSMC Stock Is a Buy, and So Do We

Taiwan Semiconductor Manufacturing Co. TSM is the world’s largest dedicated contract chip manufacturer, or foundry. It makes integrated circuits for customers based on their proprietary designs. TSMC has long benefited from semiconductor companies around the globe transitioning from being integrated device manufacturers to designers that outsource fabrication. TSMC, like all foundries, assumes the costs and capital expenditures of running factories amid a highly cyclical market for its customers. Such cyclicality stems from the fact that foundries tend to add excessive capacity during times of burgeoning demand, which can result in underutilization during downturns that hampers profitability.

Key Morningstar Metrics for TSMC

• Fair Value Estimate: $133
• Star Rating: 5 Stars
• Economic Moat Rating: Wide
• Moat Trend Rating: Stable

Economic Moat Rating

We believe TSMC’s wide economic moat stems from its cost advantage and intangible assets, which are realized from its leading position in process technology, or nodes. TSMC’s long-standing leadership in node advancement comes from its ability to correctly and consistently prioritize the right areas in which to innovate for nodes while maintaining fiscal discipline. Process technology leadership enables TSMC to improve PPA—power, (faster) performance, and (smaller) area—as well as cost per chip and time to market, which are critical for the competitiveness of computing devices. It also justifies higher prices than peers. As such, we believe that TSMC’s leading position in advanced processes will contribute to attracting and retaining more customers, more stable utilization of ever-expanding production capacities, and lower production costs, generating a higher return than its peers because of the cost advantage, and as a result, ensuring sufficient profits to fund research and development and capital expenditures on subsequent nodes.

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Fair Value Estimate for TSMC Stock

Our fair value estimate is $133 per ADR, at which TSMC would trade at a forward price/earnings ratio of 26 times and price/book ratio of 6.5 times per 2023 estimates. We use a weighted average cost of capital of 8.9% to discount our forecast cash flow. We project the company’s top-line compound annual growth rate at 15.9% over the next five years. Even with its dominant market share, we believe the company can deliver above-industry growth through a higher proportion of more valuable specialty products. Gross and operating margins are expected to dip to 51% and 40% in 2023, respectively, as a result of inventory corrections and then remain at about 53% and 42% from 2024.

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Risk and Uncertainty

TSMC operates in the highly cyclical semiconductor industry and derives about 40% of its revenue from the smartphone market. The industry alternates between shortages and oversupply. Foundries cannot always raise prices during shortages yet have to deal with high fixed costs in all downturns. TSMC’s earnings volatility has been smaller than peers’, with no earnings decline larger than 20% in the past 10 years. We expect this to continue as a result of TSMC’s dominant share in high-end products and customers’ preference for TSMC as their primary (sometimes sole) foundry. TSMC does have client concentration risk, with the largest customer contributing 26% of revenue in 2021 and the top four clients about 50%. Managing political risks has become integral to TSMC. It’s susceptible to pressure from China and the United States, as it derives most of its revenue and operates factories in both countries.

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TSMC Bulls Say

• TSMC should consistently earn higher gross margins than competitors, thanks to its economies of scale and premium pricing justified by cutting-edge process technologies.
• TSMC wins when customers compete to offer the most advanced processing systems using the latest process technologies.
• TSMC will benefit from more semiconductor companies embracing the fabless business model and internet giants designing their own data center chips.

TSMC Bears Say

• Although TSMC is the foundry leader, each generation of process technology matures and commoditizes quickly, forcing the company to deal with pricing pressure.
• TSMC’s new approach to diversify production geographically may add cost pressures with little added stability.
• Samsung and Intel are committed to heavy capital spending under the support of the U.S. government. SMIC and other state-supported Chinese foundries also lurk as potential threats.

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