Harnessing the wave of AI chips
TSMC is a contract manufacturer of semiconductors, which means it owns a number of factories to produce chips for various semiconductor companies. Many semiconductor design companies use a fabless model, where they outsource the production of their chips to a third party such as TSMC.
The construction of factories is capital intensive and high capacity utilisation is essential for their profitability. Many semiconductor companies therefore find it easier to outsource production and concentrate on their core business, i.e. chip design.
TSMC has become the largest semiconductor manufacturer in the world in terms of revenue, counting Apple and Nvidia among its biggest customers. According to Statista, TSMC has more than a 60% share of the global semiconductor fab market and produces about 90% of the world's most advanced chips.
TSMC working to increase capacity
Due to its dominant position in chip manufacturing, the company is benefiting from the demand for artificial intelligence (AI)-related chips such as Nvidia's graphics processing units (GPUs), which are used to build the infrastructure for running AI applications. Demand for Nvidia's AI chips is outstripping supply, and TSMC is working to increase capacity. Meanwhile, other companies are designing their own chips for AI, which also benefits TSMC.
This strength was evident in the second quarter, when TSMC's revenue grew more than 40% year-over-year and more than 13% sequentially.
In addition to building new manufacturing facilities to meet future demand, TSMC is also working to transition to production of 2-nanometer chip technology. Downsizing chips helps increase speed and reduce power consumption, while allowing TSMC to place more chips on a single "wafer," which reduces costs and increases capacity.
Start-up of production may negatively affect gross margins
There is speculation that Apple is trying to secure all of TSMC's capacity for the 2-nanometer technology, although the company has said that all customers have expressed interest in the technology. Although the initial production start-up may negatively impact gross margins, the company expects to reach the average faster than with 3-nanometer chip technology.
The company has also hinted at the possibility of price increases given the value it provides and the success of its customers like Nvidia. Given the current capacity constraints and dominant market share, the company is well positioned to achieve better pricing.
Is TSMC a good investment?
TSMC is riding a wave of demand for artificial intelligence chips, and the company looks well poised to transition to 2-nanometer technology and continue to expand capacity. If AI technology is at the beginning of its journey, the company has long-term growth potential ahead of it.
However, investing in TSMC also carries some risks. The first is that chip manufacturing is a high fixed-cost business, so if the company builds additional factories and future demand does not materialize, it could significantly affect profitability with low utilization of these facilities.
The United States is also considering tighter trade restrictions on chips to China. This applies in particular to more advanced chips and not to all semiconductors. In the second quarter, about 16% of TSMC's revenue came from China.
There are also long-standing concerns about a possible invasion given the company's location, and comments by former president and current presidential candidate Donald Trump about Taiwan stealing from the U.S. semiconductor industry and having to pay a higher price for its defense. However, given the island's importance in the semiconductor industry, it would be in the best interests of the US and its allies to defend Taiwan from any attack in order to prevent a global semiconductor disaster.
From a valuation perspective, TSMC trades at a forward price-to-earnings (P/E) ratio below 20 based on analyst estimates for 2025. While there are risks, this is a very attractive value given the opportunities the company has in front of it. Therefore, the recent downturn is a good opportunity to buy the stock as the company's long-term prospects look promising.
The data and information contained herein constitutes a marketing communication of HABERL Wealth Management, o.c.p., a.s. This marketing communication is for informational purposes only and the information contained herein does not constitute investment advice or a personal recommendation. Investing involves a risk of loss. You should consider and understand all risks associated with an investment before investing. Invest responsibly.