Buffett turns away from TSMC

Warren Buffett has once again made headlines in recent months. The decision of Berkshire Hathaway to trim most of its stake in Taiwan Semiconductor Manufacturing Co. only a few months after initiating the position in the company is making investors wonder whether it makes sense for them to close their own positions in the Taiwanese-based semiconductor giant as well. We could only guess the real reason behind Warren Buffett’s decision to close the position, but we do know that Berkshire Hathaway has already been divesting from China recently to minimize the geopolitical risks of its portfolio. While TSMC is not entirely exposed to Beijing’s domestic policy at this stage, the company nevertheless will remain a hostage of geopolitics which is likely going to put additional pressure on its stock, especially as Sino-American relations continue to deteriorate.

The good news though is that several growth catalysts could outweigh geopolitical risks and help TSMC’s shares to appreciate even in the current environment. Therefore, as investors are deciding whether to follow in Warren Buffett’s footsteps and divest from TSMC as well, this article will highlight all the upsides and downsides of owning the company’s shares at this stage to help make the correct decision.

Should You Be Concerned?
Despite the challenging macroeconomic environment, TSMC was able to generate aggressive returns in recent quarters as its latest earnings report for Q4 showed that its revenues increased by 26.6% Y/Y to $19.93 billion. Due to its competitive advantages in the semiconductor contract manufacturing business, TSMC simply doesn’t have any major competition which could dethrone it from its leadership position in the semiconductor industry anytime soon. Even TSMC’s main direct competitor Intel (INTC) is likely to use the services of the Taiwanese-based firm in the future due to the inability to produce its own 3nm chips.

Considering this, it’s likely that TSMC would continue to establish an even stronger presence in the semiconductor industry which will continue to increase the investment attractiveness of its stock for lots of investors. While geopolitical risks are TSMC’s biggest worry, the reopening of China along with a change of approach concerning foreign policy by Beijing could minimize those risks in the foreseeable future.

At the same time, there are currently several major growth catalysts that could help TSMC to continue to outperform expectations and create additional shareholder value along the way. The first such catalyst is the increased demand for chips in the following years. Even though it’s now certain that the revenue growth rate in FY23 would be lower in comparison to FY22 due to the weaker demand, as the Street already expects TSMC to grow its top-line at less than 2% this year, there’s a case to be made that the demand would return in the future if the disinflationary process accelerates and the macroeconomic situation improves. There are already forecasts which show that the chip demand will surge in 2024 and the fact that TSMC recently announced that it will hire 6000 engineers in 2023 alone at a time when businesses are cutting their workforce indicates that the company has everything going for it to continue to grow in the long-term thanks to its unique position in the semiconductor industry.

On top of that, TSMC has a unique opportunity to minimize geopolitical risks by opening new manufacturing facilities outside of Taiwan without covering the full costs that are associated with such an expansion thanks to the help of various programs and subsidies that are provided by American and European governments. A few months ago, TSMC has publicly admitted that it’s interested in opening its first facility in Europe and at the same time the company could also get access to $2 billion to $6 billion of American taxpayers’ funds for its factory in Arizona that should begin manufacturing Apple’s (AAPL), Nvidia’s (NVDA) and Advanced Micro Devices’ (AMD) chips there in 2024.

Thanks to all of those developments, there’s a case to be made that TSMC’s business would continue to grow and perform relatively well which could lead to the further appreciation of the company’s shares. My DCF model below tried to figure out how big of an upside TSMC’s shares represent given everything that’s stated above.

The assumptions for the revenue growth rate for the following years are mostly in-line with the Street estimates where a relatively weak growth is expected in FY23 and then a double-digit growth rate in the following years thanks to the improvement of the macroeconomic situation and a subsequent expected surge in demand for chips. The EBIT as a percentage of revenue is the same in the following years as it was in FY22 simply due to the fact that TSMC has a pricing advantage thanks to its unique positioning in the industry which gives it the option to retain its high margins and generate record earnings.

Taxes in the model are capped at 11.7% which is the average rate of the last few years, while the D&A as a percentage of revenue in the model stands at 23.4% which is the average rate of the last few years as well. The CapEx in FY23 is in line with the management’s expectations of $32 billion to $36 billion after which the expenditures as a percentage of revenue decrease as various governmental incentives kick in and help the company to cut its expansion costs. The change in net working capital in the model is capped at 3% of revenues. At the same time, the terminal growth rate stands at 3%, while the WACC rate is 9%.

This model shows that TSMC’s enterprise value is $470 billion while its fair value is $95.29 per share, which represents an upside from the current market price of ~$90 per share.

At the same time, the street’s consensus price target is $107.84 per share, which also shows that TSMC’s stock has more room to grow and could be considered a decent buy due to its growth prospects which for some investors might outweigh the idea to follow in Warren Buffett’s footsteps and unwind the position or avoid the company whatsoever.

The Only Major Risk To Consider
The only major risk to TSMC’s growth story is geopolitics. Since most of the company’s manufacturing capacity is located in Taiwan, any crisis in the Taiwan Strait would more than likely negatively affect the company’s share price while an outright invasion of the island nation by Beijing would lead to a major market rout in which TSMC would become the biggest loser. Even though Beijing changed its approach to foreign policy at the beginning of 2023 to repair its broken ties with the West, there’s no guarantee that it won’t execute another U-turn and return to the path of confrontation as was the case countless of times in the past.

As such, it’s impossible to predict how things would evolve in the foreseeable future but what’s certain is that investors who own or plan to purchase TSMC’s shares should understand that due to the company’s close proximity to the Taiwan Strait, there’s always going to be a risk that any disputes in that area would negatively affect the stock price. Other than that, there are no other major risks at this stage that could undermine TSMC’s business model due to the company’s unique position in the semiconductor industry.

The Bottom Line
While Berkshire Hathaway’s decision to close most of its stake in TSMC is surprising given that Warren Buffett himself constantly preaches to invest for the long-term and not to have a trader mentality, it’s safe to say that the Taiwanese-based company remains a solid investment for those who don’t mind being exposed to major geopolitical risks. Even though the deterioration of Sino-American relations is likely to have a negative effect on TSMC’s shares in the foreseeable future, as long as the company diversifies itself by opening plants around the globe, it would be able to continue to generate decent returns due to the lack of competition and high demand for its services.

On top of that, if Beijing sticks with the status quo while the macroeconomic situation improves, then it’s safe to assume that TSMC’s shares would be able to rally and generate decent returns for investors. At the same time, it would be smart not to overexpose your portfolio to the company as the new geopolitical reality would be limiting TSMC’s upside in the following years while risks are likely to increase.

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