Taiwan is once again the center of attention, as is Beijing. reported publicly and privately that the “reunification” of the island with the mainland is only a matter of time. Even though no one knows for sure what’s going on what would happen with Taiwan in the near future, rising tensions across the Taiwan Strait as well as deteriorating Sino-US relations will certainly put additional pressure on TSMC (NYSE:TSM) stock in subsequent years.
The good news is that the growing demand for AI chips has so far helped mitigate geopolitical risks. This is why TSMC has managed to outperform the market as a whole since I published my last article on the company in May. Although supply constraints are expected to persist for some time and help the company improve its performance Next year, there will be questions about whether it makes sense to cash out and make a profit given that geopolitical risks may start to outweigh long-term growth opportunities.
All eyes on AI
Latest results from TSMC report for the third quarter showed that its revenues declined 14.6% year-over-year to $17.28 billion, while 69% of revenues were generated in North America. Despite such a decline, it’s possible that the upcoming fourth-quarter earnings report, expected to be released next month, will be much better thanks to the fact that demand for AI chips continues to rise. To date, the delay recorded by Nvidia (NVDA) H100 GPUs continue to rise as the release of the H200 and AMD (AMD) MI300X GPUs next year will allow TSMC to significantly improve its performance considering the current situation supply constraints.
Additionally, Apple (AAPL) is currently under pressure to revive growth after several quarters of declining sales and to improve its own performance, it has already engaged to order the production of 3nm chips from TSMC for next year. It is also currently essay TSMC’s 2nm chips, which are expected to enter the volume production phase in 2025 and give the Taiwan-based foundry an additional advantage over its foundry competitors.
On top of all this, it is important to understand that the current geopolitical landscape presents not only risks but also opportunities for a company like TSMC. As capital leaves China and governments around the world attempt to secure their own supply chains, TSMC is expected to receive billions of dollars in government funding to build its manufacturing plants around the world and also minimize its own risks geopolitics.
Next year, TSMC is expected to begin construction of its first manufacturing plant in Europe in the German city of Dresden, where the government blanket half of the expenses related to the construction of the facility. The same is expected to happen in the United States, where TSMC is expected to receive funds under the CHIPS and Science Act to complete the construction of its manufacturing plant in Arizona in 2025. Additionally, Japan is also ready to finance a significant part of the factory that TSMC is building there to revive the Japanese chip manufacturing industry.
Building all these new factories will help TSMC expand its presence at a reduced cost thanks to additional funding and subsidies from governments, while minimizing its own geopolitical risks.
Major risks to consider
As expected, the potential invasion of Taiwan poses the biggest risk to TSMC’s growth. Even though chip demand is expected to increase in the coming years, most of TSMC’s factories as well as those that produce the most advanced chips will remain in Taiwan. This is why the risk premium for investing in TSMC will likely remain relatively high indefinitely.
However, potential invasion is not the only risk at this stage. The ongoing Sino-US trade war could also have a direct impact on TSMC’s future performance. Currently, China is the second largest market for TSMC after North America. In the third quarter, revenues from China accounted for for 12% of overall turnover, compared to 8% a year ago. Although sales there are increasing, the potential implementation of stricter chip export controls by the United States in the future could make it more difficult for TSMC to expand its presence and further increase its returned to the continent.
One of its main customers, Nvidia, is already barred from selling its advanced chips like A100 and H100 that TSMC produces in China. Although Nvidia has so far managed to compensate for the inconvenience caused by these restrictions by offering a less advanced version of its flagship chips, this may not be the case in the future. In my last article On Nvidia, I noted that the company will likely continue to generate aggressive returns thanks to strong demand for its chips around the world, but once demand wanes, it could become much more difficult to offset losses related to China. This will likely have a direct impact on TSMC in the future, especially as China itself attempts to become more autonomous in the chip manufacturing industry.
What is the fair value of TSMC?
Considering all these developments, I created a DCF model to determine what the fair value of TSMC is in the current environment. Revenue for the model below is expected to decline year-over-year in FY23, but then increase in subsequent years at a double-digit rate, primarily due to growing demand for AI chips . Most of the model’s other assumptions are closely aligned with the company’s historical performance. The WACC in the model amounts to 9%, while the final growth rate is 3%.
The model shows that the fair value of TSMC is $98.31 per share, which is slightly lower than the current market price of around $104 per share.
Although growing demand for AI chips will certainly help TSMC improve its performance next year, growing geopolitical risks may begin to outweigh growth opportunities for the foreseeable future. That’s why now might be a good time to cash out and look for other opportunities, especially since it appears TSMC is fairly valued at the current price.
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