Is It Too Late to Buy TSMC Stock?

Shares of Taiwan Semiconductor Manufacturing (TSM 2.71%), the contract chipmaking juggernaut better known as TSMC, recently hit a new record high after the company posted its fourth-quarter earnings report on Jan. 13.

TSMC's revenue rose 24% year over year to $15.74 billion, which beat estimates by $70 million, as its earnings grew 19% to $1.15 per ADR and topped expectations by four cents. It expects its first-quarter revenue to grow 28-33% year over year, which also exceeded expectations for 23% growth.

TSMC's robust growth rates weren't surprising, since the global chip shortage, which started in early 2020, has consistently caused the market's demand for TSMC's wafers to outstrip its available supply. TSMC also manufactures the world's smallest and most advanced chips, which makes it a crucial partner for fabless chipmakers like Apple, AMD, and Qualcomm.

Image source: Getty Images.

However, those well-known tailwinds have already caused TSMC's stock price to nearly quadruple over the past three years. Is it too late to chase that rally and invest in this linchpin of the global semiconductor market?

Reviewing TSMC's growth rates

TSMC's revenue and earnings growth decelerated in 2021 as its gross and operating margins declined. It generated 50% of its revenue from its top-tier 5nm and 7nm wafers in 2021, compared to 41% in 2020.

Period	FY 2019	FY 2020	FY 2021
*Revenue Growth (YOY)**	1%	31%	25%
5nm as a Percentage of Revenue	0%	8%	19%
7nm as a Percentage of Revenue	27%	33%	31%
Gross Margin	46%	53.1%	51.6%
Operating Margin	34.8%	42.3%	40.9%
EPS Growth (YOY)	(2%)	50%	15%

Source: TSMC. YOY = Year over year. *USD terms.

TSMC's decelerating revenue growth isn't a major concern, since it faced much easier year-over-year comparisons in 2020.

Back in 2019, TSMC struggled as the global demand for smartphone chips decelerated. However, its mass production of 5nm chips, the worsening chip shortage, new 5G devices, and stay-at-home trends during the pandemic all caused its growth to accelerate significantly in 2020.

Those trends all continued throughout 2021, and TSMC's forecast for the first quarter of 2022 indicates those tailwinds aren't weakening. Analysts expect its revenue and earnings to grow 31% and 22%, respectively, in fiscal 2022 as it remains one of the main bottlenecks of the global chip shortage.

Those growth forecasts are high for a stock that trades at just 25 times forward earnings. It also pays a decent forward dividend yield of 1.4%.

But mind the capex, competition, and cyclical challenges

TSMC remains far ahead of Samsung and Intel (INTC 1.77%), its two largest rivals, in the "process race" to manufacture smaller and more advanced chips. But to maintain that lead, TSMC needs to significantly increase its capex every year to develop smaller nodes and expand its overall capacity.

TSMC's capex already rose 65% year over year to $30 billion in 2021, and it plans to boost its annual capex to $40-$44 billion this year. It will allocate most of that capex toward increasing its production capacity for 5nm and 7nm wafers, as well as developing its newer 2nm and 3nm nodes.

TSMC can easily afford to spend that much money. Its free cash flow (FCF) only declined 13% to $9.9 billion in 2021 even after its 65% capex boost, and it still expects its FCF to easily cover its dividends this year.

Intel, which believes it can catch up to TSMC in the process race by 2024 and reclaim the lead in 2025, expects to increase its capex from $14.3 billion in fiscal 2020 to $18-$19 billion in fiscal 2021.

Intel doesn't expect to match TSMC's spending on its own. Instead, it's asking for big government subsidies in the U.S. and Europe to even the odds. If Intel can secure those funds, it might emerge as a more dangerous competitor to TSMC (as well as AMD, which relies heavily on TSMC) over the next few years.

Lastly, the chip industry's aggressive response to resolving the chip shortage could actually cause a supply glut in the near future. If TSMC, Intel, Samsung, and other foundries over-expand as the global economy slows down, they could end up with idle plants and quickly lose their pricing power. That cyclical decline could last for several years and throttle TSMC's growth.