In recent years, the need for semiconductors has risen as the world has become increasingly digitalised. This trend has accelerated in the last two years since the pandemic began.
More and more businesses are realising the need for digital transformation and are scrambling to go digital. Demand for medical equipment, data centres, and computers increased exponentially, contributing to a shortage in semiconductors.
The shortage in semiconductors has persisted throughout 2021 and is expected to continue into 2022, owing to the bottleneck created by Covid 19 production restrictions, drought in Taiwan, and global shipping congestion.
Here, I’ll explore the potential of the market in 2022 and do a deep dive into the fundamentals of the world’s largest pure-play semiconductor chipmaker to find out if 2022 will reward its investors.
Demand for Semiconductors to grow in 2022
The demand for semiconductors continued to grow throughout 2021, fuelled by digital transformation and propelled by the pandemic. Aside from consumer gadgets, every industry is increasingly reliant on digitalisation to be relevant, as evidenced by Deloitte‘s latest article.
- Demand for chips in personal devices and data centres continue to rise
In early 2021, the pandemic drove PC sales to increase by more than 50% year over year, while chips for data centres increased by 30%.
Although demand in both areas has started to drop slightly, this demand is expected to remain well above long-term averages in 2022.
- Chip utilisation in the automotive industry is rapidly increasing and is expected to continue for the foreseeable future
In 2010, the typical car contained $300 worth of microchips. As automobiles become more computerised, that amount is expected to exceed $500 by 2022.
Although there were hints by the summer of 2021 that the car industry’s chip shortfall was alleviating, lead times were still higher than usual, and automakers were still curtailing output.
- Usage of chips in the healthcare sector likely to increase
Given the surge in teleconsultation, regulators are authorising integrated home health care devices such as wearables and smart patches, whose use might reach hundreds of millions of units.
- Demand for specialised chips in AI expected to rise
For the next few years, the demand for chips specialised for artificial intelligence is expected to rise at a rate of over 50% per year, with the majority of these chips requiring the most advanced manufacturing processes.
The semiconductor shortage is likely to persist in 2022
While the shortage is expected to continue into 2022, it will be less severe overall. In mid-2021, the waiting time for semiconductors was between 20 to 52 weeks. By the end of 2022, the waiting time would be improved to around 10 to 20 weeks and that the industry will be in equilibrium by early 2023.
Nevertheless, the recovery would not be uniform across the industry, with advanced chips, especially 3,5 and 7 nanometres, continuing to be in short supply.
To compensate for the deficit, investment in semiconductors exploded.
We have venture capital firms, established players, and even the government stepping in to increase fab capacity. Currently, the construction of 29 new fabs has or will begin, which will increase global manufacturing capacity by 36% by the end of 2022.
Semiconductor Market Outlook 2022
So, what can we look forward to in the short, medium, and long term?
Short Term Outlook
Since the process of expanding chip manufacturing capacity will be lengthy, I anticipate that fabless companies like TSMC will continue to benefit from the shortage in the short term (mainly the first half of 2022).
However, if the Semiconductor Industry Association’s estimate is correct, then global semiconductor sales will increase only by 9% to $574 billion in 2022, down from the 20% increase in 2021. In that case, it could mean that semiconductor companies would slow down in their growth in 2022.
Medium Term Outlook
Over the medium-term (1 to 2 years), as the chip shortage eases there may be a risk of a supply glut, which could adversely impact the sector as early as 2023/24. As a result, semiconductor investors must consider the possibility of a cyclical downturn due to the probable supply overhang.
Long Term Outlook
That said, our world is unlikely to go back to its old days. Chip demand appears to be healthy in the long run and will likely continue to rise, which will undoubtedly benefit companies in this industry in the long run.
With a general view of the semiconductor industry out of the way, let’s talk about the world’s largest pure-play chipmaker, TSMC.
Will Taiwan Semiconductor Manufacturing Company (TSMC) be a good investment in 2022?
TSMC is one of the world’s largest semiconductor foundries, specialising solely in the production of wafers for its customers.
As a foundry, semiconductor design companies like Nvidia Corporation send their designs to TSMC, where they are manufactured. These facilities then ‘print’ the design onto silicon wafers which will be used in many of our electronic devices.
This is a highly complicated operation, especially as the nodes become smaller. There could be up to 1000 steps in the process. The environment in which these wafers are produced is likewise highly controlled, as even minor changes in external circumstances, such as the entry of ambient air, can have a huge impact on the overall operation. As such, many semiconductor companies outsource their component manufacturing to TSMC because of its technological capabilities.
TSMC had a 53% market share in the global semiconductor foundry market in 2021, while its nearest competitor Samsung had 17.1%. Not only that, TSMC is the most advanced foundry and produces over 90% of all advanced chips on the market.
And it has reaped the benefits of being the market leader, allowing it to raise its prices.
That said, after a strong rally in 2020, the stock has been relatively flat for most of 2021. Is TSM going to break out of this consolidation pattern in 2022, and which direction would it go?
Let’s explore TSMC’s business fundamentals to find out.
TSMC’s Revenue Growth
Over the last five years, revenue has steadily increased over the quarters.
In 2021, the growth rate was 16.7%, 19.8%, and 16.3% for Q1, Q2, and Q3, respectively, which appears to be in line with the increase of semiconductor sales of 20% for 2021.
Unfortunately, if the Semiconductor Industry Association’s estimate is accurate, global semiconductor sales could only increase by 9% in 2022, we may see this growth drop to 10%.
Overall, TSMC has a considerable influence in pricing as the market leader, as seen by its gross margin of 51.3%.
TSMC’s technological advantage
As the world’s most advanced foundry, TSMC focuses more than half of its output (in terms of revenue) on the most advance nodes, such as 5nm and 7nm:
Since TSMC produces such a large percentage of advanced chips, their revenue is unlikely to be as volatile as other semiconductor companies which are producing the lower end chips, even if there is a supply overhang in the medium term. This is because the demand for advanced chips made by TSMC is likely to remain high.
Nevertheless, Intel has established an ambitious goal to overtake TSMC in its four-year roadmap, a challenge of which TSMC is well aware.
TSMC may be reliant on Apple’s success
TSMC generates a substantial percentage of its revenue from the fabrication of chips used in smartphones:
And Apple is TSMC’s most important customer, accounting for around a quarter of the company’s sales. As a result, Apple is unquestionably vital to TSMC’s success.
TSMC’s exclusive partnership with Apple today speaks much about the company’s technological advancements, which even Samsung can’t match. TSMC will continue to prioritise its resources to ensure that its relationship with Apple is sustained in the long run, making its fate deeply intertwined with Apple’s success or failure.
This partnership has helped both companies, and it is hoped that it will continue to do so in the future as Apple expands its ecosystem to include electric vehicles.
TSMC’s segments to watch
That said, TSMC also has three other segments which could be up and coming.
- High-Performance Computing (HPC)
The first is its High-Performance Computing (HPC) platform, which encompasses PCs, tablets, game consoles, servers, and base stations. The COVID-19 “stay at home economy” and speedy 5G base station rollout fuelled an increase in major HPC unit shipments in 2020.
Moving forward, this market is expected to grow as a result of ongoing 5G base station deployment, rising data center AI server demand, and the ramping up of next-generation game consoles, all of which necessitate higher performance and power-efficient CPUs, GPUs, NPUs, AI accelerators, and related-ASICs.
- Internet of Things (IoT)
The Internet of Things (IoT) platform comprises a variety of connected devices such as smart wearables, smart speakers, and security systems.
Demand for Bluetooth earphones, smart wearables, and smart health gadgets grew as a result of pandemic-driven demand. As more applications are being built for IoT devices, the demand for chips which TSMC can provide will continue to increase in the future as the pandemic continues to transform our lives and work habits.
- Electric Vehicles
With the increased adoption of electric cars which are fitted with tons of chips, semiconductor foundries like TSMC will undoubtedly continue to gain from this trend.
TSMC’s Cashflow
TSMC has been improving its cash from operations.
An interesting pattern can also be observed here. For most of the financial year, you would see TSMC’s cash flow drop in the first and second quarters and subsequently rise in the third and fourth quarters. This cycle would then repeat again, but with a higher base.
Well, if this trend continues, the fourth quarter could be a strong quarter for TSMC, but cash from operations could decline in Q1 of FY22.
TSMC’s Management outlook
The growth in revenue for Q4 is in line with the company’s business outlook.
TSMC’s management predicts revenue of between US$15.4 billion and US$15.7 billion in the fourth quarter of 2021, up from $14.88 billion in the third quarter.
If everything goes according to plan, their gross margin and operating income should also remain pretty consistent.
Key Short Term Risk for investors in Semiconductor Market
The one key risk that investors in TSMC and any other semiconductor companies should beware of is a short-term oversupply. The semiconductor industry has dealt with the booms and busts of chip demand for several years. Every shortage has been followed by a period of oversupply, resulting in declining prices, revenues, and profit.
Yes, in our more digitalised world, the long-term trend for semiconductors is up and will continue to do so. As a result, betting on companies in this area could yield good long-term results.
Nonetheless, the unpredictability of its demand remains a short-term risk.
Many semiconductor foundries, government agencies, and venture capital firms are working to increase capacity as a result of the continued shortage. There should be no problem if the growth in capacity over the next few years is kept up with the increase in demand, but who knows.
To make matters worse, inventory stockpiling and duplicate booking is other reasons for the shortfall. While the impact is difficult to assess, it is possible that in the short term, when additional fabs come online, and businesses decide to use their stockpile rather than order more, there will be an oversupply.
The fact that most of TSMC’s capacity is dedicated to producing the more advanced node is a silver lining. This may help buffer the business from future industry downturns. However, I believe TSMC will still be impacted, even if it is not as severe.
Investors should keep a watch on the company’s monthly revenue for signals of a slowdown in light of the probable supply overhang. TSMC publishes its monthly net revenue as well as the year-over-year change on its investors relations webpage. This information would be extremely useful to investors in addition to the quarterly report.
Of course, income declines are not always attributable to oversupply.
In early 2021, income declines were due Covid restrictions and the drought that plagued Taiwan, affecting semiconductor industries that consume a lot of water.
Should you buy TSMC now?
TSMC’s stock performance in 2021 has been poor compared to chip stocks like AMD (NASDAQ: AMD) and NVIDIA Corporation (NASDAQ: NVDA).
TSMC traded in a range for the entire year of 2021, while NVIDIA and more recently, AMD had soared. Even though they are different businesses – one being a chip designer and the other being a chip producer, the result is nonetheless startling.
Let us not forget that TSMC plays a critical role in the semiconductor supply chain. Both the chip designer and the chip manufacturer stand to gain from the digitalisation and, soon, the metaverse. These market trends suggest either the market is overheated, or TSMC is behind the curve.
It’s worth noting that NVIDIA and AMD have substantially greater growth rates, which could be another element to consider. Having said that, you can judge if their current prices are justified. Their PEs are currently:
- AMD: 44
- NVIDIA: 89
- TSMC: 29
What about TSMC competitors?
TSMC‘s only significant competition in the high-end foundry market is Samsung.
Whereas in the low-end market, it competes against smaller and less advanced competitors like GlobalFoundries and UMC.
TSMC is already trading at a premium to its peers compared to its competitors at its current price:
- TSMC: 29
- UMC: 15
- Samsung: 15
This is undeniably attributed to its superior market position. TSMC is also trading near its historical average, implying that the price will likely remain in this range in the future if revenue remains constant.
Conclusion
TSMC is a wonderful company with excellent management that will most likely continue to dominate the semiconductor market in the years ahead.
However due to the long lead time and unpredictability of demand, semiconductors are treated as commodities, and their prices can be highly volatile. This oversupply could come into play in 2022, so if you’re investing in this sector, do keep an eye on your portfolio!
Disclosure: The author owns shares of the above-mentioned stock.