Chips are on our minds this week here at Morningstar.co.uk – not the hearty potato snack, but the essential semiconductors that run our phones, tablets and laptops, which this year have become more indispensable than ever as we work and play at home.
The companies that design and make these chips are suddenly in high demand: US firm Nvidia (NVDA) has just bought the UK’s ARM Holdings, which supplies chips for iPhones, for $40 billion from SoftBank – a previous stock of the week – which itself paid $32 billion to take the company private four years ago.
Taiwan Semiconductor, as voted by our Twitter followers, has pipped Intel and Nvidia to the post with more than 40% of the votes as our stock of the week. The Taiwanese company, which is listed in Taipei (2330v) and New York (TSM), has long been a favourite of emerging market and tech investors and its shares have surged in the recent tech rally. But what does it actually do?
TSMC manufactures up to 13 million microchips a year to customers like Nvidia, Qualcomm and Apple (AAPL), which use its semiconductors for products such as the iPhone and iPad. Why don’t these companies make the chips themselves? Often US firms design them, using home-grown (and expensive) tech expertise, and Taiwan Semiconductor does the manufacturing, taking advantage of lower labour costs in foundries in China and Taiwan.
According to Morningstar tech analyst Abhinav Davuluri, Taiwan Semiconductor has a narrow economic moat because its scale means rivals struggle to compete on cost. “Taiwan Semiconductor Manufacturing is the world’s largest dedicated contract chip manufacturer, or foundry. It makes integrated circuits for customers based on their proprietary integrated circuit designs,” he says.
“As many semiconductor companies have transitioned from integrated device manufacturers to fabless business models [ie.design only operations], TSMC has become the foundry of choice for those firms seeking to apply the latest fabrication technologies to their designs.”
Shares are Overvalued
TSMC's success has meant its shares have risen sharply in the last year – from $45 to $83 – and quadrupled over five years, pushing the company down to a one-star rating, according to Morningstar analysts, which means it is significantly overvalued. Davuluri says that at these levels, potential investors should wait for a better opportunity to buy the shares: “Given the bevy of uncertainties with potential supply chain disruption and end-market demand associated with the Covid-19 recovery, we recommend prospective investors wait for a wider margin of safety, especially as shares are up over 50% from mid-March lows.”
But recent results have encouraged investors to keep buying into the firm’s success story – second quarter sales were up 34% to more than $10 billion, at a time when most of the world was still in the grip of the pandemic. Asia-Pacific countries were among the first to impose lockdown measures as coronavirus emerged early in 2020, but were among the earliest to lift restrictions and resume economic activity, and this explains some of the region’s stock market outperformance this year.