TSMC (New York Stock Exchange: TSM) The Q3 release did not lift buying sentiments, even though TSM was beaten in 2022. It posted a YTD total return of -46.18%, below the performance of -40.2 % of ETF Semiconductor (SOXX).
As we explained in our article on pre-benefits, we expected short-term downward volatility to continue. Therefore, it seems the market remains hesitant about a material revaluation of TSMC, given the digestion of inventory at its end customers. In addition, we believe that the weak export data released recently by South Korea and Taiwan pointed to a deterioration in the global economy as investors analyzed the impact on TSMC’s future performance.
Our analysis suggests that TSMC last traded at a significant discount to its historical averages and also to its peers. Given its massive CapEx expansion over the past two years, we believe the discount is warranted as the market needs to factor in new execution risks.
Management stressed that it is confident it could show revenue growth in 2023, while the semiconductor industry is expected to show negative growth. In addition, he pointed out that inventory digestion is expected to reach its nadir in the first half of 23 before starting a recovery in the second half.
Nevertheless, TSMC’s visibility stems from what its customers expect. And the track record of its customers in their forecasts for 2022 has been quite disappointing. Additionally, with the exception of Apple (AAPL) which performed relatively well, AMD (AMD) and NVIDIA (NVDA) lost a lot of credibility with investors given their significantly lower than expected revisions.
Qualcomm (QCOM) and MediaTek (OTCPK:MDTKF) also faced challenges in their smartphone segment as growth in China slows further.
Therefore, we believe the market should reflect TSMC’s operational deleveraging risks given its high CapEx requirements, which could materially impact its operating profit performance in 2023.
Nonetheless, our analysis indicates that the blows to TSMC have created attractive entry levels for long-term focused investors. We expect the market to continue to exhibit volatility over the coming months as it attracts bearish investors/traders while forcing weaker TSMC holders to capitulate.
Therefore, investors are advised to continue to use a dollar cost averaging approach to reduce their allocation/timing risk.
Accordingly, we reiterate our buy rating on TSM.
TSMC’s massive growth in 2022 is about to end
TSMC had another strong quarter, with revenue growing 47.9% year-over-year in the third quarter. Growth was broad-based, with its two critical segments, high-performance computing (HPC) and smartphones, showing robust growth.
As seen above, HPC recorded revenue growth of 55.9%, while Smartphone recorded a revenue increase of 37.9%. However, investors are reminded that the market is looking to the future. Management has also been reluctant to release guidance for 2023, as is usually done in the fourth quarter. However, management stressed that it expects 2023 to be a “year of growth”. TSMC CEO CC Wei pointed out:
The ongoing inventory correction will also affect TSMC. [But,] we expect our business to be less volatile and more resilient than the semiconductor industry as a whole during this period. Looking ahead to 2023, with the successful ramp-up of N5, N4P, N4X and the upcoming ramp-up of N3E, we will continue to expand our customer product portfolio and increase our addressable market. So, while the ongoing correction in semiconductor inventories will affect our utilization rate in the first half of 2023, we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialized technologies, and that 2023 will be a year of growth for TSMC. (Call on TSMC FQ3’22 results)
So it’s pretty clear that management expects its revenue growth to slow significantly in 2023. However, (bullish) consensus estimates suggest that TSMC should still post high single-digit revenue growth throughout exercise 23.
As a result, TSMC is expected to deliver FY23 revenue growth of 8.1%, even though the semi-industrial industry is expected to post 0% growth (according to revised data from Refinitiv). Therefore, semi-industry analysts may still be overly optimistic in their forecasts, as TSMC pointed out that “in 2023, another year of growth for TSMC [but] the whole industry will probably decline.”
Therefore, we think the market’s current positioning indicates that it thinks Street analysts may need to revise down their forward estimates for TSMC.
Additionally, we gleaned that TSMC’s CapEx margins should still be above its long-term “mid-to-high 30” guidance. Therefore, TSMC could still undergo an extended digestion phase that Street analysts might not have reflected accordingly.
TSMC ratings have been beaten
With that in mind, we’re not surprised that TSMC underperformed most of its most important customers and the SOXX YTD in 2022. Besides the two main “culprits”, AMD and NVIDIA, which significantly revised their guidance, the TSMC’s underperformance is quite astonishing. .
However, it’s hard not to be excited knowing that TSM’s EBITDA multiples have crashed into the area of two standard deviations below its 10-year average. Therefore, we assume that the market has inflicted significant damage to its valuations, perhaps expecting more downside risks to current consensus estimates.
As such, TSM’s NTM EBITDA multiple of 5.7x is also well below the median multiple of its semi-peers of 7.8x (according to S&P Cap IQ data). Furthermore, its NTM normalized P/E of 10.7x is significantly lower than the semi-industrial forward P/E of 14x and below its SOXX peer forward P/E of 12.9x.
Accordingly, we view TSM’s valuation constructively at these levels and believe the risk-reward profile has improved significantly.
Is TSM stock a buy, sell or hold?
Despite collapsing nearly 60% from its January 2022 highs, TSM remains in a long-term uptrend.
But the market has been ruthless in digesting its rapid rise from its March 2020 COVID lows, as it digested gains to levels last seen in July 2020.
Therefore, the quick sell off of its January bullish highs likely impacted the conviction of weak hands that bought near these levels, throwing in the towel on the way down.
The break down from its June lows was also critical, as buyers who applied stop losses near its 50-month moving average were likely wiped out. However, the extent of its sell-off is emblematic of a move to force weak holders to give up. Despite this, we still need a validated bullish reversal to form on its long-term chart over the next two to three months, which is critical to maintaining its long-term bullish bias.
Given its attractive valuation and very pessimistic sentiments, we are confident about the risk-return profile at its current levels. As such, we reiterate our buy rating on TSM.