Is TSMC Stock Still Worth Buying Amid Rapid Growth and Rising Risks?

Is Taiwan Semiconductor Manufacturing Company (NYSE:TSM) the Top Mega-Cap Stock to Buy Right Now?

Taiwan Semiconductor Manufacturing Company (NYSE:TSM), or TSMC, is a darling among analysts. However, the stock has enjoyed considerable gains since my last look on April 29. Despite several favorable catalysts in play, I hold a tempered bullish stance on TSMC, primarily due to its increasingly stretched valuation. So, might there be better mega-cap opportunities out there, despite TSM’s glowing consensus rating?

TSMC: A Remarkable Run

Since my previous review, TSMC has seen its stock price rocket by 38% in just eight weeks. Investors, driven by an unquenchable thirst for AI-related companies, have propelled the stock upward. Bullish analyst updates and stronger-than-expected delivery numbers have fueled this rally, with April sales alone jumping 60% to hit $7.3 billion. This follows a 34.3% revenue growth in March, driven by unrelenting demand for AI semiconductors.

The rise has also been aided by strategic collaborations. For example, Nvidia (NASDAQ: NVDA) relies exclusively on TSMC for its cutting-edge training chips, which are in ample demand. Concerns about hyperscale demand during the transition between Nvidia’s Hopper and upcoming Blackwell series products have been alleviated, reinforcing investor confidence. The Blackwell architecture’s GPUs, manufactured using TSMC’s custom-built 4nm processor, are anticipated to maintain robust demand.

Geographical and Geopolitical Risks

Despite its towering stature as the world’s largest contract chipmaker, TSMC faces substantial geographic concentration risks. Taiwan’s susceptibility to natural calamities like earthquakes has been a sticking point for investors, demonstrated by disruptions earlier in 2024. Furthermore, the escalating geopolitical tensions with China, which claims Taiwan as part of its territory, further amplify these risks.

As a countermeasure, TSMC is expanding its manufacturing footprint beyond Taiwan, with new facilities under construction in Japan, the U.S., and Europe. This diversification aims to mitigate the concentration risk tied to Taiwan’s vulnerabilities. However, these new ventures have higher operational costs due to disparate regulatory standards, labor expenses, and supply chain challenges. The economies of scale TSMC enjoys in Taiwan are not as easily replicated abroad, prompting concerns about premium pricing for chip production in the U.S. and Germany.

Market Dynamics and Margins

The AI revolution has spurred notable shifts in TSMC’s market, particularly in demand for sophisticated, smaller processors. High-end segments like 3nm and 5nm are pivotal, contributing 9% and 37% of TSMC’s FQ1’24 revenues, respectively. The company has responded by moderately raising prices, particularly given its fully booked 3nm capacity through 2026, aligning with its goal to maintain gross margins around 53%.

Looking ahead, analysts speculate more price hikes could be on the horizon to offset rising costs in electricity, materials, and other essentials. These increasing costs are set to impact gross margins by up to 70 basis points from FQ2’24, especially as the transition from 5nm to 3nm tools already dent margins by 200 basis points.

A Valuation on the Rise

In earlier days, TSMC shares were seen as bargains, trading at valuations comparable to the average price-to-earnings ratios of the beleaguered FTSE 100 Index. Today, however, the stock looks pricier at 29.3x forward earnings and a price-to-earnings-to-growth (PEG) ratio 1.21x. The average target price is $182.56, suggesting a downside potential of 4.44%. Notably, all recent price targets have exceeded the current stock price, hence the positive ratings.

The Verdict on TSMC Stock

While our stance on TSMC remains somewhat bullish, I am cautious about its valuation, especially given its geopolitical and geographical vulnerabilities. It seems some investors might be overlooking these critical risks, a notable shift from the sentiment of 18 months ago when such factors were front and center.