Morningstar | Positive 2H Outlook Overshadows Near-Term Headwinds for Taiwan Semiconductor; Raising FVE to $34
Taiwan Semiconductor Manufacturing is the world’s largest dedicated contract chip manufacturer, or foundry. It creates integrated circuits for customers based on their proprietary integrated circuit designs. As many semiconductor companies have transitioned from integrated device manufacturers to fabless business models, TSMC has become the foundry of choice for those firms seeking to apply the latest fabrication technologies to their designs.The rise of fabless semiconductor companies has created attractive growth prospects for the foundry segment, which has in turn encouraged increased competition. However, the majority of these newer competitors are relegated to the trailing edge of chip manufacturing due to the prohibitive costs and engineering know-how associated with the leading edge. By leveraging its size to focus on the advanced end of the foundry spectrum, TSMC can combat price erosion normally associated with older products.Samsung and GlobalFoundries have both increased investments toward their respective foundry endeavors, which we think poses a long-term threat to TSMC’s recent dominance. However, with Samsung’s internally designed processors likely to account for a bulk of its foundry capacity, we think key customers such as Apple could remain reliant on TSMC’s foundry services. Nonetheless, fabless clientele are prone to switch between foundries based on process yields, pricing, and technical superiority. This reduction of switching costs has come to fruition in recent years, as TSMC and Samsung are at a comparable level of process technology, and Apple has historically used both foundries.The main advantage of being a fabless firm is the elimination of immense fixed costs related to owning and operating fabrication plants. In contrast, foundries carry the burden of managing large capital expenditure budgets amid a fluid market environment. Given the cyclical nature of the chip space, foundries tend to add excessive capacity during times of burgeoning demand that can result in underutilization during downturns that hampers profitability. As a result, we heavily scrutinize capacity expansions for firms such as TSMC.
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