Taiwan Semiconductor Manufacturing (TSM 0.72%) and Intel (INTC 1.10%) are bellwethers of the semiconductor market. TSMC is the world's largest contract chipmaker, while Intel is the leading manufacturer of CPUs for PCs and servers.
Both stocks have fallen out of favor as investors fretted over slower sales of PCs, smartphones, and other devices in a post-pandemic market. Fears of a recession and rising interest rates exacerbated that sell-off.
Over the past 12 months, TSMC's stock declined nearly 40%, while Intel's stock tumbled almost 50%. Should contrarian investors buy either of these out-of-favor chip stocks as the bulls rush for the exits?
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How TSMC and Intel became competitors
TSMC and Intel both operate their own foundries. TSMC doesn't manufacture its own branded chips -- it's a third-party contract chipmaker that only manufactures chips for "fabless" clients like Apple (AAPL -0.14%), AMD (AMD 0.64%), and Nvidia (NVDA 2.97%). Intel primarily uses its foundries to manufacture its own CPUs, but it's been gradually accepting more orders from other fabless chipmakers.
For many years, Intel stayed ahead of TSMC in the "process race" to manufacture smaller, denser, and more power-efficient chips. But that changed after TSMC, with the financial backing of Apple, started to install ASML's (ASML 0.20%) pricey extreme ultraviolet (EUV) lithography systems in 2014. EUV systems are used to etch circuit patterns on the world's smallest silicon wafers, but Intel stuck with its lithography machines instead of buying ASML's systems.
Intel subsequently struggled to manufacture smaller and denser chips, and it eventually fell behind TSMC in the process race in 2020. As a result, AMD, which outsourced its production to TSMC, pulled ahead of Intel with more advanced CPUs. Apple, which previously installed Intel's CPUs in its Macs, also replaced those aging chips with its own TSMC-produced silicon.
Intel is now buying more EUV systems, but it will need to pour tens of billions of dollars into that expansion to catch up to TSMC and AMD. For now, TSMC -- and its top clients like AMD and Apple -- remain at least two chip generations (in terms of node size and transistor density) ahead of Intel in the process race.
Cyclical headwinds vs. existential challenges
TSMC generated 41% of its revenue from the smartphone market in the third quarter of 2022. Another 39% came from the high-performance computing (HPC) market, 15% came from the Internet of Things (IoT) and automotive sector, and the rest came from other markets.
One near-term headwind for TSMC is the slowing growth of the smartphone market. Apple, its largest customer, has been struggling with severe supply chain disruptions in China. Inflationary headwinds and longer upgrade cycles are also preventing consumers from buying new phones.
Another major headwind is the decelerating sales of high-end PCs in a post-pandemic market. AMD, Nvidia, and even Intel (which outsources the production of its discrete GPUs to TSMC) are major customers for TSMC's HPC segment, and all of these chipmakers are bracing for a tough cyclical slowdown in 2023. TSMC might offset some of that deceleration with the growth of its smaller auto and IoT divisions.
Analysts expect TSMC's revenue to only rise 7% in 2023 as its EPS declines 5%. That would represent a significant slowdown from analysts' forecasts for 43% revenue growth and 69% earnings growth in 2022.
TSMC's headwinds are cyclical, but Intel's challenges are arguably existential. Intel's share of the PC CPU market plunged from 82% to 63% between the fourth quarters of 2016 and 2022, according to PassMark Software, as it lost ground to AMD's cheaper and more advanced CPUs. Intel's server business also remains heavily exposed to the unpredictable macroeconomic headwinds for big enterprise and data center customers.
Intel generated 53% of its revenue from its client computing group (which mainly serves the PC market) in the third quarter of 2022. Another 27% came from its data center and AI division, while the rest came from other types of chips and services. Its core businesses will likely face macro and competitive headwinds in 2023 and beyond.
Intel believes it can catch up to TSMC in the process race by 2024, but that's a tall order that will require heavy spending and some support from government subsidies. For now, analysts expect Intel's revenue to decline 15% in 2022 and slide another 4% in 2023. They expect its earnings to plunge 64% in 2022 and drop 4% in 2023 as the company continues to chase TSMC.
The valuations and verdict
Both stocks look cheap: TSMC trades at just 12 times forward earnings, while Intel has a slightly higher forward price-to-earnings ratio of 13. But at their current valuations, TSMC is a much better buy than Intel because it's growing faster, it's better diversified, and it remains far ahead in the process race. Intel isn't doomed yet, but it has a lot of work to do before it can be considered a viable turnaround play, or even a stable blue-chip dividend stock.
