The demand for semiconductors has skyrocketed in a world that continues to rely on technology for everything from communication to healthcare. However, despite solid secular tailwinds behind chip manufacturing, the industry is no stranger to cyclical downturns, and many companies have struggled to navigate the ebbs and flows of the volatile chip market.
Even Taiwan Semiconductor (TSM 1.26%), one of the industry's leading players, has been hit hard by the recent downturn. But there are signs that the company is poised to bounce back quickly. Despite its struggles over the last year and a half, today is an excellent time for long-term growth investors to consider putting it on their buy list. Here's why.
Revenue growth driven by AI and mobile phones
As society's thirst for the latest technology increases, the need for faster and more efficient computing is rising. And that's where Taiwan Semiconductor (TSMC) comes in as the largest contract chip manufacturer in the world. TSMC is a pure-play foundry, meaning it doesn't design or sell chips to end users but specializes in manufacturing them for other companies. And with cutting-edge technology at its disposal, it can meet the ever-growing demand for more powerful semiconductors.
One area that the company's management is particularly excited about is the proliferation of artificial intelligence (AI) technology, including generative AI. As AI requires massive computing power, TSMC's expertise in this area means it is well positioned to increase AI-related revenue in the coming years. Overall, the proliferation of AI is a significant tailwind for TSMC, making the company an excellent long-term investment for investors seeking exposure to the growth of AI.
Here is what the company's CEO, C.C. Wei, has to say about AI:
Today, server AI processor demand, which we define as CPUs, GPUs, and AI accelerators that are performing training and inference functions, accounts for approximately 6% of TSMC's total revenue. We forecasted this to grow at close to 50% CAGR [compound annual growth rate] in the next 5 years and increase to low teens percent of our revenue. The insatiable need for energy-efficient computation is starting from data centers and we expect it will proliferate to edge and end devices over time, which will further long term -- which will drive further long-term opportunities.
Another significant growth engine for the company is mobile phones. TSMC is a major supplier of chips for the mobile phone industry, and as the mobile phone market returns to growth, it should benefit. Research company International Data Corporation (IDC) projects that global shipments of smartphones will rebound from a 3.2% decline in 2023 to 6% growth in 2024. If IDC is correct, it bodes well for TSMC's results to recover next year.
Don't look for a great performance in the short term
High-performance computing (HPC) and mobile phones make up 77% of TSMC's revenue. As seen in the image below, HPC declined by 5% and smartphones dropped by 9% sequentially.
Image source: Taiwan Semiconductor.
Its HPC and mobile phone platform declined because of a mismatch between semiconductor supply and demand. In 2020 and 2021, there was a sharp increase in demand for HPC and mobile phone chips due to the COVID-19 pandemic, leading device manufacturers to build up inventory in anticipation of continued high demand. However, chip demand slowed in 2022 as the pandemic eased and consumers spent more time outside and less time on their phones and the internet.
Unfortunately, things only worsened as rising interest rates slowed global growth coming into 2023. Manufacturers like Apple suddenly faced difficulties selling their products. Consequently, they reduced manufacturing and ended up with surplus semiconductor components in their inventory, leading them to buy fewer chips from TSMC. The following chart shows that its revenue growth, profitability, and free cash flow fell off a cliff in 2023.
TSM Revenue (Quarterly YoY Growth) data by YCharts
Don't expect things to get much better soon. Management forecast third-quarter revenue of between $16.7 billion and $17.5 billion, a year-over-year decline of 15.5%. It also expects the gross profit margin to drop to between 51.5% and 53.5%, and the operating profit margin to decline to between 38% and 40%. Until chip supply and demand rebalance, don't expect TSMC's results to improve much.
Now is the time to consider buying TSMC
As a result of the spate of negative news in the semiconductor industry, the company now sells at a price-to-earnings (P/E) ratio of 15.18 compared to its median P/E ratio of 21.48 over the last five years -- which many would consider a sign of an undervalued stock.
TSM PE Ratio data by YCharts
If you are searching for a solid long-term growth opportunity that sells for a reasonable price, consider adding a few shares of TSMC to your portfolio today.
