Shares of the world's largest advanced semiconductor manufacturer, Taiwan Semiconductor Manufacturing (TSM -4.91%), have been back on the wane in recent months. TSMC stock got hot with the rest of the chip stock universe starting in autumn 2022 (as measured by the iShares Semiconductor ETF), but a current downturn in the semiconductor market and a lackluster quarterly earnings report from TSMC has sent the share price back down recently.
Data by YCharts.
In spite of troubles, though, TSMC has said it will continue spending lots of money on new chip manufacturing equipment. That looks like a green light for investors in chip fab equipment stocks, as TSMC gears up for lots of new chip demand in the years ahead. But does it make TSMC stock a buy now?
Mixed signals for investors in Taiwan's most important company
Some 90% of all of the world's most advanced semiconductors (think chips powering high-end smartphones like the Apple iPhone, to artificial intelligence chips from Nvidia) are made by Taiwan Semiconductor Manufacturing. Indeed, the advancement of technology itself relies on ever more powerful computing, so it's a bit of an understatement to say that TSMC controls a critical choke point in the global economy.
This incredible position is what has led many investors to drop some serious coin on TSMC stock. Even Warren Buffett's Berkshire Hathaway, noted for its historical aversion to high tech, made a (brief) sizable investment in TSMC in 2022.
However, there are reasons to be wary of investing in this top chipmaker. Perhaps most notably is the threat of China invading Taiwan as it pursues its "One China" policy to reunify the island with mainland China. I'm not a political commentator, but there's constant bluster surrounding this issue that leads many to believe a Chinese invasion of Taiwan is a real possibility within the next decade. Suffice to say that would be disastrous for TSMC -- and the world.
This particular geopolitical risk was apparently just one reason Buffett and company quickly reversed course and sold most of their position in TSMC late in 2022.
For now, though, let's focus on numbers to inform an investment decision.
As expected, TSMC reported a slight year-over-year dip in revenue and earnings per share (down 5% and 6%, respectively) during the first quarter of 2023. Some of this was due to lower shipments of silicon wafers (given the slump in chip demand, driven by lower PC and smartphone sales), as well as negative currency exchange rate effects from a strong U.S. dollar.
But the real metric many investors were eyeing was TSMC's capital expenditures (or capex, spending on property, plant, and equipment) for 2023. Capex plans for 2023 remain unchanged from previous guidance, expected to be in a range of $32 billion to $36 billion, down from $36.7 billion in 2022. This contradicts recent media reports that claimed TSMC was going to slash its capex budget in response to the chip downturn. It also reinforces TSMC's confidence that customer demand will pick up pace the second half of this year and into 2024.
Implications for the chip industry
A wealth of data can be gleaned from TSMC's simple statement that its capex plans remain unchanged despite a nasty looking global economy for 2023.
First, the roadmap for technological advancement isn't taking any detours, owing to the fact that computing technology relies so heavily on the latest and greatest chips made by TSMC.
Second, chipmakers see so much demand beyond any economic weakness in 2023 that they're willing to keep spending heavily to boost their production and manufacturing technology prowess now.
And third, it's full steam ahead for the chip manufacturing industry, since TSMC's leadership -- and willingness to spend heavily to defend that leadership -- will keep pressure on other leading chip manufacturers like Samsung and Intel to keep spending heavily as well.
In other words, TSMC is still the leader in chipmaking, and has the money to sustain that leadership.
Is TSMC the best chip manufacturing stock to buy now?
Given TSMC's rosy outlook beyond the present market slump, shares look like a steal at just 13 times trailing 12-month earnings per share, or 25 times free cash flow. But is the stock a buy now?
That third point above is why I prefer chip fab equipment stocks over the manufacturers. Companies like TSMC make the chips, but they can only do so thanks to incredibly complex pieces of machinery purchased from chip fab equipment businesses. The five largest in this semiconductor sub-industry are ASML (ASML -1.94%), Applied Materials (AMAT -2.73%), Lam Research, Tokyo Electron, and KLA.
According to industry association SEMI, there's a downturn in revenue brewing for these businesses in 2023 as chip manufacturers manage their spend on equipment (a primary driver of that capex for TSMC). However, TSMC's capex outlook for 2023 remaining unchanged is great news for ASML, Applied Materials, and others. 2023 might be a bumpy year, but hundreds of billions of dollars worth of new chipmaking equipment will be needed in the near future.
Whether it's TSMC, Samsung, Intel, or someone else, all chip fabs need to place orders with ASML, Applied Materials, and friends. And if a Taiwan invasion worries you, any disruption to the island means chip manufacturing operations will need to be shifted elsewhere (an endeavor that's already underway). That means even more new fab equipment will be needed.
In other words, chip fab equipment makers are in a position of control when it comes to development of semiconductors. TSMC's first-quarter 2023 earnings report didn't offer much reason for the stock to command a higher valuation, especially considering geopolitical risks for Taiwan. I remain on hold with TSMC stock. Rather, I believe it gave the green light to buy chip equipment stocks like Applied Materials for this year and beyond, as TSMC will be highly reliant on those suppliers for its future success.
