Taiwan Semiconductor: AI Exposure With Less Bubble Hype … – Seeking Alpha Feedzy

 

Logan Kane

22.58K Followers

Summary

Taiwan Semiconductor Manufacturing Company has seen a 38% YTD increase, largely due to excitement over its production of Nvidia’s GPU chips.I wouldn’t necessarily buy TSM stock before earnings, but the relative value against American tech peers is instructive about how risk and reward are perceived by investors.TSMC makes more income, has a lower market cap, and has a more stable earnings trend than Apple or Nvidia.The potential for China to invade Taiwan is a risk factor for TSMC, but this would also severely impact American tech companies that rely on TSMC’s supply chain.

shih-wei/E+ via Getty Images

Taiwan Semiconductor Manufacturing Company (NYSE:TSM) has followed the broader NASDAQ rally this year, rising by 38% YTD. Of course, that’s nothing compared to Nvidia’s (NVDA) 220% return, but it’s a strong return nonetheless. A fun fact about TSMC is that of Nvidia’s GPU (i.e. AI) chips, although TSMC makes plenty of money elsewhere, chiefly from for Apple (). TSMC is much cheaper than its customers- Nvidia trades for 60x non-GAAP earnings after massive upward revisions, while Apple trades for 33x. TSMC trades for roughly 21x forward earnings. TSMC reports earnings on Thursday of this week, giving clues not only to their own business but also into the fortunes of Apple and Nvidia.

Data by YCharts

For one, Nvidia (like most tech companies) typically reports non-GAAP earnings, so financial statement net income is a nice reality check on the actual level of profitability of the company that accounts for huge investments needed in R&D to stay competitive. Second, we can then easily compare net income to valuation. And in this case, after upping guidance, Nvidia should make about $11-$12 billion this year (great numbers by the way) but is valued for $1.2 trillion. NVDA earnings are a moving target, but this should be in the ballpark. On a GAAP basis, that’s 100x earnings or more. When/if the chatbot boom fades (or competitors gain ground on Nvidia’s technological lead), then shareholders who have super high expectations will be crushed. This is a story that has happened over and over again- we hear plenty from Apple shareholders but nothing from those who went all-in on Research in Motion, the maker of the Blackberry smartphone. Nvidia might win and might lose, but the financial statements tell a story of cyclicality, making the valuation highly suspect. Granted, Nvidia makes a lot more per GPU sold than TSMC does, but they also incur far more R&D costs.

However, American tech companies are not immune! TSMC is the sole supplier to Nvidia, and if there really is an invasion of Taiwan then Nvidia’s supply chain would likely be just as wrecked as TSMC’s. Ditto for Apple, which is heavily dependent on TSMC for iPhone chips. In fact, TSMC has about 55% of the global market share for contract chip fabrication and almost all of the most advanced processors. As a Time Magazine piece noted, that’s far more than OPEC has over oil. Taiwan is so crucial to the U.S. economy, yet the island is only 81 miles from the Chinese mainland at its closest point. Chinese President Xi Jinping has repeatedly said that Taiwan will be “reunited” with China, and has asserted China’s right to take Taiwan by force. The U.S. government is obviously concerned after the pandemic chip shortages and moved in 2022 to subsidize the construction of massive chip factories across the country. TSMC is building a huge new factory in Arizona to mitigate this. Chip fabs are notoriously water-intensive, but apparently, the water can be recycled. If Taiwan is concerned about a potential war, they aren’t spending a ton of money on defense. Taiwan spends about 2.4% of its GDP on defense, which is less than the US’s roughly 3.5% all-in figure. Compare this with heavily militarized countries like Saudi Arabia (6.6% of GDP), Israel (5.2% of GDP), or even Greece (3.9%). If Taiwan’s government is particularly worried about an invasion, it isn’t showing up in their spending. It’s worth noting that island nations tend to fare well in war. War wouldn’t necessarily mean TSM stock would go to zero, as evidenced by the performance of the British stock market during WW2. However, losing a war is terrible for returns, as evidenced by the returns from the German stock market during WW2. Even still, when markets in Germany reopened in 1948 and 1949, they didn’t go to zero.

Does TSMC deserve the deep discount it carries to American tech peers like Apple and Nvidia, despite having similar supply chain risks? The single biggest risk to TSM stock is the threat of war. Is Taiwan’s low defense spending indicative of a low risk of war, or of complacency? Could investors be overestimating the risk of war on TSMC while underestimating the risk on its American customers? Are there any other opportunities in the AI space that are being overlooked?

This article was written by

Logan Kane

22.58K Followers

Author and entrepreneur. My articles typically cover macroeconomic trends, portfolio strategy, value investing, and behavioral finance. I like to profit from the biases and constraints of other investors. Paywalled articles are available along with 1,000+ other authors by subscribing to Seeking Alpha Premium.You can read some more of my work for free here on my Substack.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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