By Chris Bailey :
Every Monday, I look at the top equity market winners and losers, over the past week, as published in the Financial Times using their FT Global 500 index . Even though I am aware of most of the moves, inevitably there are a few that slip through.
This Monday, the biggest loser was Taiwan Semiconductor Manufacturing Company ( TSM ) or TSMC for short. Its corporate website, from which the slides below have been taken can be accessed by pressing here.
Over the last 25 years, TSMC has established itself as the clear global number one dedicated outsourced semiconductor foundry. It is embarrassingly far ahead -
This success has been based on adoption of new technology as this chart nicely highlights. Better/faster/smaller capabilities within a chipset due to lower nanometers hugely augment the competitive edge of a product. Currently, it's ramping into 20nm and talking about 16nm -
Using the results just published, today TSMC has a very material business at 28nm. It still have a lot of business to convert. The pressure on marginal competitors is intensifying. You can see why the whole industry has oligopolised much more over the last 10 years.
In terms of headline results ( a link to the Q2 presentation document can be found here ), I would summarize them as 'good progression' judging by the continued growth in margins -
I note though that Q3 2013 guidance suggests growth is slowing to a more equivalent to high single digit growth year-on-year and margins have limited scope to show more progress:
Why is this? Well as CFO Ho put it this way on the conference call:
Every new technology, when it comes to the mass production, it in early beginning it always starts with lower margins. But when the quantity starts to go up, maybe after seven or eight quarters, the margin will be getting closer to corporate average. So we expect that will happen for 20-nanometer as well.
And turning to revenues -
In third quarter, computer will decline the most, followed by communications with modest decline. We expect consumer industrial for TSMC will go up in third quarter.
We should not be surprised about PCs (see the chart below). Consumer industrials represent non-telecommunications mobile devices as well as gaming.
The key growth area in terms of underlying product is consumer industrial, namely, mobile devices and gaming. These remain structural growth areas.
Pulling together new technologies, revenues and margins to some extent is capacity utilisation. Trends here are watched closely. Chairman Chang made some interesting remarks on this -
The fourth quarter down could be a little more severe than the last year, than the fourth quarter down last year. And, however, the first quarter down will not be as severe as the first quarter down this year…And the first quarter, however, could be reasonably flat from the fourth quarter. And, however, the second quarter, next year's second quarter will rebound. It's going to be, I believe, a very strong one, just as this year's second quarter rebound was.
I think this is a very important quote. Guidance last year over 'iffy' Q4/Q1 combined with market uncertainties pushed the stock to an August low before investors saw through this in the run during the six months from August (again assisted by broader markets).
I liked the way that TSMC presented its cash flow statistics. It would have been easy to have just concluded cash went up rather than highlighting actually that continued high investment levels (the ramp to 20nm) meant underlying FCF was small negative. Corporate straightforwardness like this is good.
Investment levels next year will be about akin to this year.
Chairman Chang also discussed any perceived threat from Intel and/or Samsung -
On foundry-to-foundry competition, I believe we are competitive... On a grand alliance versus IDM competition, I believe we are more than competitive...so while other competitors, or at least some of the other competitors, are talking about building capacity and even actually building capacity, I think that we will have a much higher utilization.. this has happened before, when -- this in fact has been happening all along, in the last 15 years or so. While we always build capacity, we knew who our customers would be and at least we knew at least approximately what their demand would be, real demand. While we build our capacity on that kind of knowledge, our competitors often build capacity on speculation…
I would agree on this.
TSMC is a quality operator. Technology-wise it is a leader, I am heartened by the competitor relevant comments and it is still performing albeit it is not now showing margin/sales increases year-on-year that it was. Issues are centred on these harder comps and the continued need to invest in order to stay ahead.
At a current market cap (in Taiwan) of NT$2515bn, TSMC has just over 10% of its market cap in cash today. That makes the EV around NT$2290. Using the mid-points of the company's guidance, this puts it on x10 EV/ebit. That is a level that captures my interest for this global leader.
If I use the Friday close for the NYSE quote, I note the share is approximately halfway between the August 2012 level and the 2013 YTD high. Broadly speaking, this range extremes are equivalent to 2013 x8 EV/ebit and x12 EV/ebit. For a technology leader like TSMC, I would value it on the latter measurement giving me a (US quote) share price target of US$19.5.
This makes the share a buy today especially as I note in the Taiwanese market the share fell 6%+ on Monday as heavy domestic holders lightened up holdings.
I would augment the position sub US$15 and sub US$13.
The share also offers a useful 3%+ yield.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in [[TSM]] over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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