Taiwan Semiconductor Manufacturing Co. (TSM, Financial) is an exceptional investment by my analysis on a pure business front. However, taking into consideration the current macroeconomic uncertainties surrounding China, the U.S. and Taiwan, I am acting defensively even though I am currently a shareholder.
My analysis concludes with a hold rating, largely influenced by China-U.S. tensions, and an analysis of Chinese perspectives related to Taiwan, the company's main country of operation.
Putting Taiwan Semiconductor into context
Taiwan Semiconductor is predominantly a semiconductor manufacturer, but also has operations in technology development, foundry services and custom design services. In conjunction, its strategies include sophisticated global investments, global supply chain management and a diverse product portfolio.
The majority of operating revenue currently comes from the United States, accounting for 66% of revenue, with China second at 10.8%.
As of 2022, Apple Inc. (AAPL, Financial) is Taiwan Semiconductor's largest customer, accounting for 23% of revenue. Nvidia Corp. (NVDA, Financial), Intel Corp. (INTC, Financial) and Advanced Micro Devices Inc. (AMD, Financial) are also major clients.
The company currently has nearly 60% of the semiconductor foundry market share. That places it in a position to continue dominating in advanced semiconductor manufacturing in ways its competitors cannot compete with.
Margin analysis
Taiwan Semiconductor is exceptionally well-positioned in terms of financial performance. The company's GF Score is currently 99 out of 100, indicating high outperformance potential.
My analysis shows this to be correct when isolating Taiwan Semiconductor in terms of past financial performance, current price and future estimates. The issue, discussed later, remains the macroeconomic concerns. I believe this significantly hampers the long-term outperformance potential of the stock.
Taiwan Semiconductor particularly shines on margins, with some of the highest in the industry. Gross margins are currently 58.63%, operating margins are 47.96% and net margins are 42.28%. This shows an immense level of efficiency and a business moat that allows the company to charge prices and manufacture at costs that are uncommon in the industry.
To put the company's net margins into perspective with the wider semiconductor industry, its net margins are ranked better than 97.37% of companies in GuruFocus' dataset. Taiwan Semiconductor's net margins are particularly high in comparison to its historical margins, with a strong upward trend over 15 years, a minimum of 30.82% and a maximum of 43.86%.
Texas Instruments Inc. (TXN, Financial), for comparison, has net margins of 39.21%. That is a strong competitor on margins, and I posit Texas Instruments may be an overall better company for a semiconductor industry investment, primarily for its geopolitical security from domestic U.S. manufacturing.
Taiwan Semiconductor has margin dominance over its competitors largely because of its advanced capabilities. For example, chip-on-wafer-on-substrate (CoWoS) has high demand from Amazon's (AMZN, Financial) AWS, Cisco (CSCO, Financial) and Nvidia, among others. CoWoS is one example of the unique advanced capabilities the company possesses that other chip manufacturers are lagging on.
As reported by Reuters, Taiwan Semiconductor's July forecast estimated a 10% reduction in 2023 sales and up to a 4% reduction in operating margin. Recent third-quarter earnings saw a 14.6% drop in year-over-year revenue, as well as a 25% reduction in net profit. While that does signify a short-term downside for the stock, the long-term outlook is much more promising and I see this as a potentially opportune time to invest in the company at a small weight in my portfolio.
Value analysis
When analyzing Taiwan Semiconductor on value, the picture becomes increasingly speculative. The reason for this is that while the company has strong innate valuation measures, the market is already pricing in heavy skepticism about how it will fare if China decides to actively invade Taiwan. The Chinese military has performed multiple drills around Taiwan recently, but have yet to turn these drills into a hot war.
From a discounted cash flow analysis using earnings without non-recurring items as a growth measure, the GuruFocus discounted cash flow calculator produces a margin of safety of 40.26%. That calculation uses an average 16% 10-year growth rate, followed by a 4% 10-year terminal stage, with the discount rate set at 11%.
That is a very promising result, and one that is certainly feasible given the current financials, historic growth rates and future estimates. I am tempted to invest heavily in Taiwan Semiconductor based on the discounted cash flow readings alongside the elite financials it is recording. Due to my investment strategy being heavily informed by my macroeconomic and geopolitical considerations, I am not investing heavily in the stock because the wider operational picture is more complex than past performance and future financial estimates.
The price-to-tangible book value of the company is less ideal with a ratio of 4.37. The price-earnings ratio, however, is a more promising 14.32. To compare this to peers, Texas Instruments has a price-to-tangible book value of 10.72 and a price-earnings ratio of 18.59. Samsung SDI (SSDIF, Financial) has a price-to-tangible-book value of 1.8 and a price-earnings ratio of 14.37. That places Taiwan Semiconductor in a relatively strong position, but my main concern is the company's tangible book value when compared to its current price. With a company with such immense margins and market dominance, such price inflation above tangible book value is common, but it still adds a minor area of uncertainty to owning the shares, especially in light of any potential macroeconomic unsettlement related to international relations.
The GF Value Line shows the stock to be 38.34% below its GF Value. I do think this is accurate based on the intrinsic company fundamentals, but at the moment the true value of Taiwan Semiconductor is speculative, more so than any other elite business in the world. If macroeconomic factors were less acute, the GF Value reading would be spot on and an investment would be warranted by my analysis without a doubt.
Geopolitical concerns
The current uncomfortable circumstances, including declarations from China that are increasingly hostile, like this excerpt from a 2022 statement by the Ministry of Foreign Affairs of the People's Republic of China, do not make me confident that an investment in Taiwan Semiconductor will be smooth sailing in the short to medium term:
"The United States, for its part, has been attempting to use Taiwan to contain China. It constantly distorts, obscures, and hollows out the one-China principle, steps up its official exchanges with Taiwan, and emboldens “Taiwan independence” separatist activities. These moves, like playing with fire, are extremely dangerous. Those who play with fire will perish by it." -Ministry of Foreign Affairs of the People's Republic of China, 2022
Indeed, China claims Taiwan to be an "inalienable part of China's territory… clearly recognized by United Nations General Assembly Resolution 2758 of 1971" in the same statement.
I am extremely cautious about investing in Taiwan Semiconductor heavily because it is one of the focal points of what seems to be rising geopolitical tensions, which are only worsened by current infringements on U.S. global dominance like the Ukraine-Russia war.
I see an optimistic scenario where China and the U.S. come to a mutual legal agreement on the status of Taiwan, whilst also continuing to allow Taiwan Semiconductor to build fabs offshore. The company currently has fabs outside of Taiwan in China, Japan and the United States. However, given current tensions, I do not see this as the likely outcome. If strict measures are not taken by the U.S. to respect China's historical perspective, I see evidence that tensions could erupt quite severely. This is especially true considering Ray Dalio (Trades, Portfolio)'s latest analyses, which indicates a declining American economy meeting a rising Chinese economy in what historically has statistically resulted in significant wars and the establishment of a new international order.
Of particular note is Taiwan Semiconductor's building of a mega-plant in Phoenix, Arizona, complementing a further progressed plant called Fab 21 near the same site. The mega-plant reportedly has seen recent delays due to labor shortages and union pushback, culminating in a 2025 estimated finish line. This is slowing both the company's global expansion and domestic semiconductor production capacity for the U.S. However, these plants represent an important step for the United States in domestically producing advanced semiconductors.
My analysis indicates an investment in Taiwan Semiconductor is extremely risky at present as the U.S.-China tensions are not solely influenced by semiconductor manufacturing. The company is only one small part of a larger global escalating macroeconomic environment; one that it is bound to be the brunt of if conditions worsen and a larger-scale war breaks out.
Hold
My analyst rating is hold for Taiwan Semiconductor Manufacturing. The reason for this is that although the company represents exceptional margins, market dominance and a compelling intrinsic valuation, the current geopolitical risk surrounding escalating global tensions with the U.S., China and Taiwan does not present a stable investment opportunity for the immediate future. I am concerned that overly weighting a portfolio with the stock could see extreme volatility if geopolitical tensions become more severe.
