Nvidia has been the chip stock in vogue this year, with investors pushing the company past a $1 trillion market cap. But another semiconductor company, one with close ties to Nvidia, could be the next to join it and the other tech giants in the $1 trillion club.
Taiwan Semiconductor Manufacturing (TSM +0.40%), known as TSMC, supplies all the chip designers with the actual final products that go into smartphones, laptops, and data centers.
While the company has lots of exposure to the AI chip boom -- including as a supplier of all of Nvidia's AI chips -- it has felt pressure from the downturn in semiconductors. It's the market leader in chip manufacturing, grabbing the majority of the market. And while that means cyclical setbacks are inevitable, it also means it will be a major participant in the next boom in semiconductors.
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McKinsey estimates the global semiconductor industry will grow more than 80% this decade, surpassing $1 trillion in revenue by 2030. This is one of the best stocks to take advantage of that secular growth, and it has the potential to reach a $1 trillion market cap in the next few years, joining Apple, Amazon, Microsoft, and Alphabet -- not to mention Nvidia.
The must-have chipmaker for the next generation of semiconductors
There's a reason TSMC commands more than half the market for chip manufacturing. It's one of just two companies capable of producing the highest-performing, most power-efficient semiconductors.
Its newest-generation process uses a 3-nanometer node. This smaller node (an improvement over the previous generation's 5nm) allows it to fit more transistors onto a piece of silicon. Increased transistor density means faster processing speeds with less power consumption. The only other chip foundry producing 3nm chips at scale is Samsung.
Apple started using TSMC's 3nm process for its A17 chips found in the iPhone 15. It has been a longtime customer of TSMC's, using it for iPhone chips since the launch of the iPhone 6 in 2014, switching away from Samsung. When it launched its own chip designs for Macs in 2020, it used TSMC's 5nm process.
It is becoming increasingly expensive to make further advancements in shrinking down dies to fit more transistors onto a chip. With its huge market share, that gives TSMC an advantage. It can leverage the fixed costs of research and development and equipment to continually push the envelope in technological capabilities. That in turn cements its position as the go-to chipmaker for any company like Nvidia and Apple looking to produce cutting-edge chips.
TSMC's competitive advantages in scale and technology should support its fat gross margin, which came in at 54.3%. That will go down as it ramps up 3nm nodes, but management expects to maintain a long-term average gross margin wider than 53%.
NYSE: TSM
Key Data Points
Turning the corner
While artificial intelligence (AI) chips are booming, most of TSMC's business has nothing to do with AI, at least right now. More than a third of its business is tied to smartphones, which have seen shipments decline for eight straight quarters as of midyear.
But there are signs of the company turning the corner, and moving toward balancing its capital expenses with its production. Management expects to slow capital expenditures in 2024 as it focuses on greater efficiency, increasing its output for AI chips, and hedges against macroeconomic uncertainty.
Meanwhile, it expects the 3nm process to ramp up faster than expected, indicating strong demand for Apple's iPhone 15, and it gave a better-than-expected outlook for the fourth quarter.
Its new fourth-quarter forecast suggests a 5% decline in revenue for the full year, an improvement from the 10% decline it projected at the end of the second quarter.
While investors have awarded the stock since that earnings release, it still trades at an attractive valuation around just 16 times forward earnings estimates. That's one of the best values you'll find in the semiconductor industry.
Joining the $1 trillion club
TSMC's market cap today is still a far cry from $1 trillion at $480 billion. It will have to more than double to reach $1 trillion. But that's not out of the question over the next few years.
First, I think there's room for multiple expansion. The stock has been beaten up amid a cyclical downturn. Its five-year median price-to-earnings multiple is 21.5. If its price expands to that level in 2024, it'll add about $200 billion in market cap.
Moreover, TSMC will benefit from a growing number of companies using the fabless, contract business model. That includes some of those members of the $1 trillion club developing their own chips for AI and data centers, which will power the future growth of the industry. With its leading technology, it's positioned to outperform the overall market, which could grow at a double-digit percentage rate for the rest of the decade (barring major macroeconomic setbacks).
Despite already being a giant in the industry, there's a lot to like about TSMC at this price. It's a strong candidate to join the $1 trillion club over the next few years.
