Company Overview

Taiwan Semiconductor Manufacturing Company Limited (TSMC), which was established by Dr. Morris Chang in 1987, produces semiconductor products that are used in smartphones, high-performance computing (HPC), Internet of Things (IoT), automotive and digital consumer electronics. The company, headquartered in Taiwan, has subsidiaries in the United States, the Netherlands, Canada, China and Japan. The shares of the company were listed on the Taiwan Stock Exchange in 1994; its American Depositary Shares (ADSs) are traded on the New York Stock Exchange.
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TSMC focuses on providing foundry services to other businesses; it does not have its brand of semiconductor products. TSMC relies on its Research & Development (R&D) effort to meet the changing needs of its customers using technologies such as advanced process, specialty, mask, silicon stacking and advanced packaging technologies. The company continues to invest in technologies and manufacturing capacities. It established a new subsidiary, Japan Advanced Semiconductor Manufacturing Inc., in December 2021 in conjunction with Sony Semiconductor Solutions Corporation and DENSO Corporation. An advanced semiconductor fab is expected to start production in the United States in 2024.

TSMC is governed by a ten-member board of directors headed by Dr. Mark Liu. There are six independent directors on the board, namely Sir Peter L. Bonfield, Ms. Kok-Choo Chen, Mr. Michael R. Splinter, Mr. Moshe N. Gavrielov, Mr. Yancey Hai and Mr. L. Rafael Reif. Dr Liu became the board chairman of TSMC in 2021. Dr. Liu has served in different positions since he joined the company in 1993. Dr. C.C. Wei doubles as the board vice chairman and chief executive officer of TSMC.

Investment Thesis

TSMC’s chips are widely used in computers, communications systems, high-performance servers, data centres, automotive equipment, industrial equipment, game consoles, digital cameras, artificial intelligence-enabled devices, IoT and wearables. Being a capital-intensive business, its capacity expansion drive should help drive down its costs, improve returns and profit margins.

The use of advanced manufacturing process (5-nanometer and 7-nanometer resolution) in producing its chips is a testament to its technological innovation. The 5-nanometer (5nm) process, which was first used by TSMC in 2020, is an improvement on the 7-nanometer (7nm) in terms of the speed and power consumption of its semiconductors. In fact, 5nm chips accounted for most of the revenue growth in 2021. Both 5nm and 7nm chips produced 50% of wafer revenue in 2021 compared to 41.2% in the prior year.

TSMC has not relented; R&D spending continues to increase. The sum of NT$124.7 billion spent on R&D in 2021 amounted to 7.9% of total revenue. It has expended about 8% of its revenue on R&D over the past twelve years. The company is working to deliver on its 3nm technology soon. 3nm technology will provide platform support for mobile and HPC applications. It is also working on the 2nm technology. These technologies would improve the performance of its chips.

The strong demand for smartphones, high computing power, and Internet of Things have fueled revenue expansion of the company. In 2021, the revenue of NT$689.5 billion generated from its smartphone platform was equivalent to a 9% revenue growth or 43.8% of the total revenue of the company. High performance computing platform declared NT$582.9 billion revenue in the 2021 fiscal year, 34.9% better than the prior year’s performance. Internet of Things platform’s sales revenue was NT$132 billion in the year under consideration, compared to NT$108.8 billion in the previous year. Automotive and digital consumer electronics platforms recovered from two consecutive years of decline in revenue by posting NT$66.6 billion and NT$55.2 billion, respectively in 2021.

TSMC is not cash-strapped. It had a cash flow of NT$1.1 trillion in the 2021 fiscal year. It produced a free cash flow per share of NT$10.18 in spite of the continuous spending on capital. Return on equity has been close to 24% in the last ten years while return on assets averaged 16.8%.

Valuation

We have valued TSMC stock and arrived at an estimate ranging from NT$575.61 and NT$701.13 per share.

Financial Overview

Despite the supply constraints and the impact of COVID-19, revenue peaked at NT$1.6 trillion in 2021, gaining 18.5% year-over-year. In the prior year, TSMC reported a 25.2% revenue growth to NT$1.3 trillion. Wafer revenue was responsible for 89% of the total revenue (2020: 88.4%) in 2021 while other sources produced the remaining 11% (2020: 11.6%). The 7nm chips had the highest contribution to wafer revenue, accounting for 31.3% of the wafer revenue in 2021 (2020: 33.5% ). The increment in wafer revenue was mainly from 5nm and 7nm nodes. While the 5nm node produced 71.7% of wafer revenue increment in 2021, the 7nm accounted for 20.9%. Wafer revenue from 7nm chips increased by 12.9% to NT$439.1 billion in the year under review compared to 55.8% in the preceding year. 5nm node’s revenue jumped by 192.5% year-over-year to NT$261.6 billion.

TSMC still makes a lot of revenue from the earlier manufacturing process of 28nm and 40/45 nm nodes. They were responsible for 18.3% of wafer sales revenue (2020:21.5%). Wafer revenue from 28nm chips grew by 3.8% to NT$152.8 billion in 2021 from NT$147.3 billion in the earlier year. The revenue from the 40/45nm chips gained 1.3% year-over-year to NT$103.3 billion.

The United States (US) remains the highest contributor to revenue. 64.3% of total revenue or NT$ 1 trillion was realised in the US in 2021 as against 61.6% or NT$809.7 billion in the preceding year. Taiwan, the company’s headquarters, made NT$204 billion in revenue compared to the previous year’s revenue of NT$129.1 billion. The revenue made from China shrank by 29.6% to NT$164.6 billion in 2021.

A 22.3% rise in the cost of sales to NT$767.9 billion resulted in a fall in gross profit from NT$711.1 billion in 2020 to NT$819.5 billion in 2021. In absolute terms, operating income rose 14.7% to NT$650 billion in 2021. Operating income margin which was 42.3% in 2020 slipped to 41% in 2021. Though Profit Before Tax (PBT) increased by 13.4% to NT$663.1 billion in 2021, PBT margin dropped 1.9 percentage points year-over-year to 41.8%. In the same manner, Profit After Tax (PAT) added NT$78.9 billion or 15.2% year-over-year; PAT margin which was 38.7% in 2020 fell to 37.6%.

Total assets, supported by increases in cash and Property, Plant & Equipment (PPE), exceeded NT$3 trillion. Cash and cash equivalents were 28.6% of total assets while PPE formed 53% of total assets. They both produced 85.4% of the increment in total assets in the 2021 fiscal year. The shareholders’ fund, which peaked at NT$2.2 trillion, gained 17.3% over the prior year. Though it has increased, the debt level does not pose a threat to TSMC. Total debt increased from NT$365.2 billion to NT$749.1 billion, representing a 105.1% year-over-year leap. But total debt only amounted to 20.1% of total assets (2020:13.2%) and 34.5% of total equity (2020: 19.7%). There was massive coverage for debt obligations because the company had a lot of profit and cash to offset them when due.

Business Risk

The rapid pace of technological change in the semiconductor industry requires regular spending on R&D. The company must be innovative and come up with newer and better technologies to compete favourably in the market. These technologies have inherent uncertainty and complexity, which could hurt profitability. The huge capital expenditure associated with the business may increase indebtedness and make it difficult to recoup the investment if the consumers’ purchasing power dwindles. If the company fails to comply with government regulations in producing and testing its products, business disruption and loss of earnings may occur.

Recommendation: Buy