Shares of Taiwan Semiconductor (NYSE:TSM) dipped by about 5% last Thursday following the company’s Q2 report, with results coming in somewhat mixed. Specifically, the semiconductor manufacturing giant is currently facing several industry headwinds, resulting in shaky demand dynamics that have, in turn, negatively affected its short-term financials.
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Although Taiwan Semiconductor may continue to face such pressure for the remainder of the current year, substantial improvements are anticipated starting next year. The semiconductor industry is expected to experience a vigorous rebound in earnings as macroeconomic uncertainties gradually ease, revitalizing demand for semiconductors.
Overall, I believe that shares of Taiwan Semiconductor appear heavily discounted against the company’s future earnings growth estimates, likely signaling a buying opportunity following the recent dip. Accordingly, I am bullish on TSM stock.
What is Currently Negatively Affecting TSM’s Operations?
TSM’s operations have faced several challenges lately due to the semiconductor industry’s undergoing a down cycle. As the leading semiconductor foundry, TSM plays a crucial role in enabling the world’s largest technology companies, such as Apple (NASDAQ:AAPL), Nvidia (NASDAQ:NVDA), Qualcomm (NASDAQ:QCOM), and Advanced Micro Devices (NASDAQ:AMD), to bring their chips to life using its proprietary technology.
The current short-term downturn can be attributed to a convergence of various factors, including surging inflation, geopolitical tensions, and the ongoing aftermath of the pandemic, during which consumers purchased electronic devices in bulk.
This complex interplay of these circumstances has resulted in heightened macroeconomic uncertainty, a decline in consumer spending, and notable fluctuations in the demand for semiconductors. Moreover, reduced spending on consumer electronics, such as PCs, smartphones, and tablets, has further contributed to a diminished demand for the semiconductors that power these devices, ultimately impacting TSM’s performance.
Q2 Results: Financials Weighed Down by Macroeconomic Challenges
Due to the current challenges just mentioned, TSM’s financials were weighted down in Q2. In particular, second-quarter revenue fell 6.2% sequentially or 13.7% year-over-year to $15.7 billion, with global economic conditions dampening end-market demand, which led to an unfavorable inventory adjustment by TSM’s customers.
Gross margins also fell by 220 basis points sequentially to 54.1%, primarily reflecting lower capacity utilization and higher electricity costs. Thankfully, more rigorous cost control and a more favorable foreign exchange rate partially offset these challenges. Nevertheless, despite the industry’s cyclical downturn, TSM continued to invest in R&D for its N3 and N2 technologies development, which further compressed operating margins by 350 basis points to 42%. As a result, EPADR (earnings per American Depositary Receipt) fell by 26.5% to $1.14 from last year.
Weak Performance to Persist This Year, but a Recovery Looms
A somewhat soft environment for semiconductors is expected to persist throughout the rest of this year. TSM’s management expects Q3 revenues to land between $16.7 billion and $17.5 billion, which indicates a 9.2% sequential improvement but a year-over-year decline of 14.9% from last year’s $20.2 billion.
Further, gross margins are expected to range between 51.5% and 53.5%, while operating margins should range between 38% and 40%. This indicates a further decline from last quarter’s gross and operating margins of 54.1% and 42.0% and a steep drop from Q3-2022’s gross and operating margins of 60.4% and 50.6%.
That said, TSM’s performance is expected to improve in the near future as macro challenges ease, lifting the industry from its current downturn. Management noted their optimistic Q4 outlook during the post-earnings call, anticipating a substantial ramp-up of TSM’s 3-nanometer production, which should boost gross margins by three to four percentage points from Q3. Additionally, management foresees a long-term gross margin of 53% and higher, indicating a potential recovery in profitability.
This theme is also reflected in Wall Street’s estimates, which also seem to forecast a recovery in the semiconductor industry and, therefore, in TSM’s revenues and profitability. While earnings per ADR are anticipated to be approximately 25% lower in Fiscal 2023 compared to the previous year, they are forecasted to make a robust rebound of 24% to reach $6.12 in Fiscal 2024. Moreover, earnings per ADR are expected to experience a significant increase of 34% to reach $8.19 in Fiscal 2025.
Such wild swings in profitability highlight TSM’s highly-cyclical business model, serving as a reminder that this year’s seemingly unfavorable results are typical market reactions and should not overly concern investors.
Is TSM Stock a Buy, According to Analysts?
Regarding Wall Street’s sentiment, Taiwan Semiconductor features a Strong Buy consensus rating based on four Buys and one Hold assigned in the past three months. At $125.00, the average TSM stock price target implies 27.2% upside potential.
Takeaway – A Discounted Valuation Relative to Earnings Growth Potential
While Taiwan Semiconductor stock faced a 5% dip following its admittedly mixed Q2 report, the company’s short-term challenges are not unexpected given the cyclical nature of the semiconductor industry. As macroeconomic uncertainties gradually ease, a robust rebound is expected, which should result in a strong rebound in TSM’s profitability.
In fact, based on Wall Street’s estimates, the stock is currently trading at approximately 16 times its Fiscal 2024 expected EPADR and 11 times its Fiscal 2025 expected EPADR, presenting exceptionally attractive multiples for an industry behemoth like TSM, upon which a great chunk of the globe’s semiconductor manufacturing capacity relies.
Consequently, I view the current dip in TSM stock as a compelling buying opportunity, given that shares seem heavily discounted when considering their earnings growth projections.
