Artificial Intelligence (AI) is causing a paradigm shift in today's modern technological world. AI technologies are making their presence felt in all walks of life -- be it education, business, investing, or home management. Not surprisingly, artificial intelligence has also become a major investment trend on the stock market, and has captivated the interest of both amateur and seasoned investors.
However, it is essential to understand that all AI-powered companies are not created equal. Only a few of these companies are in a position to benefit significantly from the ongoing AI rush. Taiwan Semiconductor Manufacturing (TSM 0.27%), also called TSMC, seems strategically positioned to capitalize on this opportunity, as it is playing a major role in building the hardware infrastructure required to run complex AI workloads.
Here's why TSMC could be a smart long-term pick.
NYSE: TSM
Key Data Points
AI catalyst
As the largest contract chip manufacturer in the world, TSMC is known for manufacturing chips for multiple fabless chip designers and large consumer electronic companies including Nvidia, Advanced Micro Devices, and Apple.
Not surprisingly, TSMC has become a major beneficiary of hyperscalers shifting from traditional servers to AI servers. Thanks to its cutting-edge semiconductor process technologies, the company is pivotal in manufacturing the advanced semiconductor content used in these AI servers, such as GPUs, AI accelerators, and networking processors. In fact, according to one estimate, TSMC currently manufactures nearly 90% of the world's advanced AI processors.
Although most existing AI accelerators (specialized high-performance computing machines for AI workloads) have been manufactured with 5-nanometer or 4-nanometer technology, many customers now opt for TSMC's advanced 3-nanometer process technology. Since 3-nanometer chips can fare better in processing power and energy consumption than previous-generation chips, they are better suited for power-hungry AI data centers. TSMC expects revenue from 3-nanometer chips to more than triple on a year-over-year basis in 2024. The company is also gearing up for volume production of 2-nanometer chips in 2025. Management also expects 2-nanometer chips to be bigger revenue contributors for the company than 3-nanometer or 5-nanometer chips in the first two years post-launch.
TSMC expects AI processors to be the largest contributor to its overall revenue growth in the coming years. The company expects revenue contribution from AI processors to grow annually at a compound annual growth rate (CAGR) of 50% for the next five years, accounting for over 20% of the company's revenue in 2028.
High-performance computing business
The surge in AI-related demand for hardware has made the high-performance computing (HPC) business the largest revenue contributor for TSMC.
In the first quarter of 2024, HPC accounted for 46% of the company's total revenue. HPC-related demand partly offset the negative impact of smartphone business seasonality in the first quarter. The HPC business is also expected to support TSMC in the long run.
Impressive financials
TSMC boasts impressive financials, despite the headwinds in the smartphone business. The company has guided for revenue to grow in the low to mid-20s percent range in U.S. dollar terms in 2024. At the end of the first quarter, TSMC had 1.9 trillion in New Taiwan dollars as cash and marketable securities and reported 255 billion in New Taiwan dollars of free cash flow.
Expanding geographic footprint
Although TSMC accounts for almost 61.2% of the global semiconductor foundry market, a big chunk of this business is concentrated in Taiwan.
To reduce its geographic concentration risk, TSMC plans to build three facilities ("fabs") in Arizona. TSMC expects volume production of 4-nanometer chips in the first fab in Arizona in the first half of 2025. The company has scheduled volume production of 2-nanometer and 3-nanometer chips at the second fab in Arizona by 2028. Finally, the company plans to start production of chips based on 2-nanometer or advanced technologies in the third fab in Arizona by the end of 2030. The U.S government is also helping TSMC in this endeavor by offering $11.6 billion in grants and loans to the company.
TSMC has also planned specialty technology fabs in Japan and Germany to further expand its geographic footprint.
Reasonable valuation
TSMC is currently trading at a price-to-earnings (P/E) ratio of 29, lower than the semiconductor industry median PE multiple of 32. Although not exactly cheap, the valuation seems quite reasonable considering that analysts expect its revenue to grow year-over-year by 24% in 2024 and by 20.4% in 2025.
These are impressive estimates considering the weakness in demand in the smartphone end market (which accounted for 38% of the company's revenue in the first quarter). Smartphone seasonality and lengthening in the smartphone replacement cycle are notable challenges for TSMC. However, the company is confident about the strong high-performance computing-related demand for its chips, which can help partly offset the adverse impact of the slowdown in the smartphone business.
Hence, TSMC now seems to be a smart pick for investors considering its critical role in building the hardware infrastructure for AI systems, its technological superiority, and its reasonable valuation.
