TSM TOP 10 POSITION FH24 RESULT---Text Book Success

As TSM approached a TOP10 position for me, a deeper piece was required.

Understandable business

TSMC is the leading global semiconductor fabrication business. the semiconductor business is unusual in exhibiting both underlying growth and cyclicality.

TSMC reports their segments by platform type and node (product). The below shows the business migration for the last few June year ends. % of total revs.

The above highlights several aspects of the business. The business is dominated by High-performance computing and the Smartphone industry. HP computing has been the growth driver while smartphones have been cyclical. HP hardware is the main driver of the AI industry with a product flow-through from TSMC to NVDA and then to the large Hyperscalers like MSFT, GOOGL, AMZN, TLSA and META et al. The demand here is enormous and expected to be ongoing, at this stage. Smartphone demand has been more cyclical and dependent on the product refresh cycle. There is an opportunity that AI edge demand, that is, putting AI capabilities in smartphones and PC’s will invigorate a much larger product cycle in the short to medium term. The other smaller categories, like IOT and Auto, probably are longer-term growth options as the complexity of appliances and vehicles will continue to increase.

The progression of node delivery is an indication of TSM's technological leadership. To this should be added the important category of advanced packaging in which TSM leads. The final table indicates the pricing of each wafer and shows how each node has a much higher price, and more complex nodes have a much higher development cost. The margin outcomes will be discussed below but the above table shows the ability of the business to garner higher prices for its products over time and the progression to more complex nodes in the business mix. These are positive drivers.

Below is an estimate of the customer mix in 2023, the strong recent growth of NVDA in 2024 should be considered here and some commentators think NVDA is now the largest client.

The list shows the top-tier operators in the industry. It is no empty boast that all industry leaders deal with TSM.

The below chart shows the foundry share. Some competitors such as Samsung are quite competitive in segments of the industry. No one offers the complete package to the standard of TSM. Intel is attempting a comeback. As an integrated operator, it plans to make chips, design and use chips, so competes with its customers. INTL has ambitious plans and has to be monitored in case it shows signs of success. From the outside, it appears a huge task.

To sum up, AI demand in different guises is expected to drive much higher growth over the next several years. There could be bumps in the road but some forecasts are for a doubling of chip usage from current levels. Demand could be more, the critical part is the return that the companies spending these large capex builds are seeing (MSFT, GOOGL, AMZN), it is early days but positive.

Operating History

TSM eps growth has been relatively consistent and strong, 15% over time, 18%pa for the last 5 years, and with a 5Y roll spread of between 5-25%. R2 is 78% which is good.

ROE averaged 25% over the last 12 years with a range of 22-34%. TA has compounded at 13-15% over many years. Reinvestment, over the last 12 years, has been 53%. All internally generated the cashflows and the spending.

NPM has averaged 36%, with a 12Y range of 31-45%.

GM has averaged 53% over the last 5 years but with some variability. That speaks to pricing strategy. TSM has been criticised for not being aggressive enough on pricing. Certainly, it could be argued they have built a large customer surplus. The company calls its pricing strategic, it targets a good but not extreme return on its investments and monitors the ability of customers to sustain higher prices. Currently, with NVDA's extraordinary profits, pricing could be increased here. With capacity so constrained across the board selective price increases are likely.

The cash flow and capex numbers are interesting. Cashflow has exceeded reported profit in every year. Not too sure why maybe conservative accounting. The capex reinvestment is large but has been funded completely by internally generated cashflows. Therefore the company can self-fund an aggressive CAPEX rollout, due to the profitability of the business.

Management made an interesting comment on capex discipline: TSM will not repeat the errors of 2021/2, when they expanded capacity and were caught out by the volatility in demand.

Management

TSM has just replaced its CEO with a well-known and experienced internal successor. Below is TSM's mission statement from its Annual report. From what I can see it stands scrutiny.

TSMC’s Vision Our vision is to be the most advanced and largest technology and foundry services provider to fabless companies and IDMs (integrated device manufacturers), and in partnership with them, to forge a powerful competitive force in the semiconductor industry.

To realize our vision, we must have a trinity of strengths: 1. Be a technology leader, competitive with the leading IDMs 2. Be the manufacturing leader 3. Be the most reputable, service-oriented and maximum-total-benefits silicon foundry

TSMC’s Mission Our mission is to be the trusted technology and capacity provider of the global logic IC (integrated circuits) industry for years to come.

TSMC’s Core Values

Integrity Integrity is our most basic and most important core value. We tell the truth. We believe the record of our accomplishments is the best proof of our merit. Hence, we do not brag. We do not make commitments lightly. Once we make a commitment, we devote ourselves completely to meeting that commitment. We compete to our fullest within the law, but we do not slander our competitors and we respect the intellectual property rights of others. With vendors, we maintain an objective, consistent, and impartial attitude. We do not tolerate any form of corrupt behaviour or politicking. When selecting new employees, we place emphasis on the candidates’ qualifications and character, not connections or access.

Commitment TSMC is committed to the welfare of customers, suppliers, employees, shareholders, and society. These stakeholders all contribute to TSMC’s success, and TSMC is dedicated to serving their best interests. In return, TSMC hopes all these stakeholders will make a mutual commitment to the Company.

Innovation Innovation is the wellspring of TSMC’s growth, and is a part of all aspects of our business, from strategic planning, marketing and management, to technology and manufacturing. At TSMC, innovation means more than new ideas, it means putting ideas into practice.

Customer Trust At TSMC, customers come first. Their success is our success, and we value their ability to compete as we value our own. We strive to build deep and enduring relationships with our customers, who trust and rely on us to be part of their success over the long term.

Balance Sheet

The balance sheet has almost always carried net cash. The internal cash generation is strong.

Other

The accounting looks straightforward and conservative. Amortization is low since there are no large acquisitions, and SBC is small.

The average PE over the last 5 years has been 22X and the last 10 years around 17-19X. these low numbers perhaps indicate the capital nature of the business, some inherent cyclicality and not being a US business.

The main risks highlighted are macro, geopolitical and cyclical challenges to the business. Other concerns are that increased regulatory product restrictions on China will hurt the business. TSM has averaged 12% of revenues from China over the last couple of years. Probably below its semiconductor peers.

No doubt a Chinese invasion of Taiwan would be catastrophic, not only for TSM but the whole semiconductor supply chain.

The revival of Intel or other competitors does arise from time to time and has to be watched. Clients may attempt to spread risk and balance competition between foundries but this has been a very measured process so far.

CONCLUSION - VALUATION

The company is a textbook example of internally driven consistent growth. TSM’s leadership position will be very difficult for competitors to reign in and most appear content to follow along. Remaining the lynchpin between equipment suppliers and customers while being the technological leader is the key to success and TSM holds the position with some strength. The company has a successful culture and a record of innovation success.

At $184, assuming a 5Y 20% eps compound growth with an exit PE of 21X (not accounting dividends) generates a 6%pa return. Becomes very interesting around $155.

Please note the disclaimer.

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