Taiwan Semiconductor Manufacturing (TSM 2.71%) is the clear-cut leader in the semiconductor fabrication space. By some accounts, it currently accounts for about 58% of the global market for contract chip manufacturing, and it's responsible for making more than 90% of ultra-high-end semiconductors.
The fab leader undoubtedly has a lot of things going for it, but investors can't dismiss the potential bearish catalysts out of hand. If you're thinking about buying TSMC stock or already own it, read on for a look at potential dynamics and events that could determine what comes next for the company.
Buy: TSMC has a powerful competitive edge
Think of some big names in the tech industry -- it's virtually certain that these companies rely either directly or indirectly on chips made at TSMC's fabrication plants.
Apple, the world's largest company, relies on TSMC for the fabrication of its internally designed chips. Leading processor companies including Nvidia and Advanced Micro Devices depend on its services too. Even Intel, which stands as the third-largest chip manufacturer in the world, outsources some of its fabrication to TSMC.
Outside of its relatively rare contracts with vertically integrated chip companies like Intel, Taiwan Semiconductor doesn't compete with its customers. Clients can sleep easier knowing that the fab giant has no interest in appropriating their designs and attempting to undercut or disrupt their operations.
The chip fabrication business is also highly capital intensive. Even when would-be rivals are willing to invest the needed funds, it could take a decade or more for them to build plants capable of producing the cutting-edge silicon TSMC delivers. In that time, TSMC could focus on pushing its own capabilities forward, and would likely retain competitive edges that would prevent most of its customers from risking their product release timelines and quality standards on unproven new players in the space.
Buy: Positioned to capitalize on chip industry growth
Facing some macroeconomic headwinds and lapping a period that saw exploding demand for new chip nodes, TSMC's revenue dipped roughly 4.8% year over year in 2023's first quarter to approximately $16.7 billion. On the other hand, earnings per share in the period still rose by 2.1%.
With demand for new chip nodes still high, the company has continued to record fantastic margins. Taiwan Semiconductor posted a 56.3% gross profit margin, a 45.5% operating margin, and a net income margin of 40.7% in the first quarter. Management expects margins to remain strong over the long term even with some cyclical swings.
While sales and margins will likely continue to be somewhat cyclical owing to the launch of new chip nodes and some demand variation, cyclicality now appears to be being reduced by the increasing integration of chips into hardware across virtually all product sectors. Outside of short periods of relatively limited demand downturn, the chip sector now appears to be moving toward secular growth mode.
Semiconductor equipment manufacturer ASML projects that worldwide semiconductor revenues will rise at a 9% compound annual rate from 2020 through 2030, and reach annual sales exceeding $1 trillion at the end of that period. With TSMC posting such strong margins and enjoying dominant competitive positioning, it seems poised to be one of the key beneficiaries of that growth.
Sell: TSMC is at the heart of an international quagmire
TSMC is one of the most important tech companies in the world. Unfortunately, it's also at the center of rising tensions between the U.S. and China. This makes accurately valuing the fab leader significantly more complicated.
China has long viewed Taiwan as part of its territory, and many foreign policy analysts believe that Taiwan Semiconductor's vital role in global chip production will result in the rising world power making military or diplomatic moves to seize greater control of the island nation. Last year, U.S. Secretary of State Anthony Blinken said that China had accelerated its timeline for annexing Taiwan and would be willing to use military force if necessary. If China were to invade Taiwan, former national security advisor to the Trump administration Robert O'Brien has suggested that the U.S. and its allies could move to destroy TSMC's fabs to prevent them from falling into rival hands.
Whether or not China ultimately conducts military actions in an effort to take over Taiwan or attempts to achieve reunification through political or economic means, there are a variety of geopolitical scenarios that could ultimately hurt TSMC's business and share price.
TSM PE Ratio (Forward) data by YCharts
Is TSMC a smart investment right now?
TSMC is a great company that appears (on a surface level) to be valued attractively for long-term investors at roughly 20 times this year's expected earnings.
But there are factors beyond the company's financial strength and growth outlook that investors will have to take into consideration. There's a real risk that the company will be negatively impacted by political and military situations in Taiwan, and worsening relations between the U.S. and China.
In totality, I think that TSMC would be a worthwhile portfolio addition, but investors should be cautious about making it a large part of their holdings. The stock is riskier than a quick look at the company's fundamentals, valuation profile, and growth opportunities would suggest.
