TSMC's stock remains undervalued, but why does the AI chip market continue to be a battlefield despi

In the global semiconductor industry, TSMC holds an unshakable position akin to Apple’s dominance in smartphones—both control core technology and command significant market share.

Amidst the current artificial intelligence (AI) wave, TSMC once again finds itself at the forefront thanks to its cutting-edge node technology and global expansion efforts. From the mass production of 3nm technology to the upcoming 2nm node, TSMC’s innovations are driving fundamental shifts in AI.

These advancements place TSMC as a key player in AI chip manufacturing, granting it dominance in high-performance computing (HPC) and smart devices. TSMC’s third-quarter financial results reinforce this, showing a 36.4% year-over-year increase in revenue and a 51.3% surge in net profit, indicating the intense demand for its advanced nodes.

Advanced nodes: The “growth engine” of the AI era

TSMC’s leadership in the semiconductor sector is most apparent in its continual advancement of cutting-edge node technology. In the semiconductor industry, each leap in manufacturing translates to smaller sizes, lower power consumption, and higher computational capacity. For the AI and HPC markets, TSMC’s 3nm and soon-to-launch 2nm nodes are the growth engines.

In Q3 2024, TSMC’s 3nm technology contributed 20% of its wafer revenue, with 5nm and 7nm nodes making up another 49%. These nodes dominate TSMC’s revenue, particularly within AI and HPC applications, establishing them as one of the company’s primary income sources.

While the 2nm (N2) node will be game-changing, TSMC’s 3nm (N3) and its derivatives are expected to remain its flagship products until at least 2025. The company is actively refining its N3 node, including versions like N3E and N3X, tailored to various performance and power efficiency requirements, especially for application-specific integrated circuits (ASICs) and high-end CPUs used in data centers.

N3’s presence is crucial for bridging the technology gap leading up to N2, keeping TSMC ahead in competition. Against Samsung’s 3GAP and Intel’s RibbonFET 20A technologies, TSMC’s nodes offer a leading alternative through 2024 and 2025.

You may wonder, “What do these pricing differences between nodes imply?” TSMC’s N2 process is projected to cost over $30,000 per wafer, while N3 wafers are expected to cost about $18,500, and N4/N5 roughly $15,000. This signals a 65%-100% increase in cost with each technological leap. Despite this increase, the performance and efficiency gains these nodes offer mean they’ll remain highly in demand for years, particularly in AI and HPC sectors.

For AI training and HPC applications, these advancements are essential due to their need for massive computational power to process vast amounts of data. Increased efficiency translates to reduced operating costs and a more sustainable future.

Regarding 3nm technology, TSMC has also introduced versions like N3E and N3X, which cater to diverse needs for performance and energy efficiency across different applications. These innovations not only help TSMC maintain its competitive edge but also bridge the gap leading up to the upcoming 2nm technology. Compared to competitors like Samsung and Intel, TSMC remains ahead in technological maturity and production capability, strengthening its industry leadership.

For investors, understanding these technological advancements and pricing shifts is crucial. TSMC’s continuous breakthroughs in advanced node technology are not only a testament to its market competitiveness but also a critical “growth engine” for future financial performance. Although costs are rising, strong market demand for these advanced nodes gives TSMC enough leverage to maintain profitability and its market-leading position.

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Top-tier client support from advanced nodes

TSMC’s leadership in advanced node technology has secured it a significant market share in the global semiconductor market, particularly among tech giants like Apple and Nvidia. Apple has long been one of TSMC’s most critical clients, relying on its high-performance chips for smartphones, tablets, and computers. Nvidia’s demands in AI and HPC make TSMC an indispensable partner.

According to TSMC’s latest earnings report, Apple accounts for around 25% of TSMC’s revenue, with Nvidia closely following. Their strong demand for advanced chips is a crucial driver of TSMC’s revenue growth. TSMC’s 3nm and 5nm nodes are especially favored by these clients for their enhanced performance and lower power consumption, helping Apple and Nvidia stay competitive in the market.

In Q3 2024, advanced nodes (3nm, 5nm, and 7nm) accounted for 69% of TSMC’s wafer revenue. These technologies have not only strengthened TSMC’s market position but also effectively deterred competition from Samsung and Intel. Compared to these rivals, TSMC excels in technological maturity, production capacity, and client customization, securing its industry-leading role.

Nvidia’s AI chips are almost entirely reliant on TSMC’s manufacturing capacity, underscoring TSMC’s irreplaceable role in the AI and HPC markets. This monopoly provides TSMC with substantial bargaining power, as clients struggle to find alternative suppliers, further reinforcing TSMC’s market stability.

The strategic value of client relationships

You might ask, “Why are these major clients so crucial?” These clients are not only TSMC’s primary revenue sources but also represent the forefront of semiconductor applications. Companies like Apple and Nvidia, with ongoing innovation in AI, 5G, and HPC, have insatiable demand for advanced nodes. TSMC, with its leading process technology, sustains this position and achieves mutual growth with its clients.

Through close collaboration with major clients, TSMC has strengthened its market share and established a formidable moat, enhancing its resilience and growth prospects amidst challenges.

Global strategic expansion: Boosting capacity, reducing risk, capturing market share

TSMC is constructing new wafer fabs in the U.S., Japan, and Europe. This expansion not only aims to increase production capacity but also to mitigate dependency on a single region, thereby improving supply chain resilience.

In Arizona, TSMC’s 4nm plant is slated for mass production by 2025, signifying the company’s commitment to serving local markets and meeting U.S. demand for advanced semiconductors. This move brings TSMC closer to major clients like Apple and Nvidia while aligning with U.S. policies favoring local manufacturing of advanced technology, ensuring supply chain security and stability.

In addition to the U.S., TSMC has invested $11 billion in a new semiconductor plant in Dresden, Germany, to meet the automotive and industrial market needs in Europe. The Dresden facility marks a pivotal step in TSMC’s regional diversification and reflects the company’s strategy to address geopolitical risks. This investment positions TSMC to capture growth opportunities in Europe’s automotive electronics and industrial control sectors.

By establishing production bases across multiple countries, TSMC effectively mitigates risk, ensuring steady chip supplies for clients. For major clients like Apple and Nvidia, this assurance of supply is essential, as they rely on TSMC’s advanced nodes for their core products.

These expansions are not only a solution to fragile supply chain risks but also a way to seize regional market opportunities. For instance, Europe’s demand for automotive electronics and industrial automation continues to grow, creating a need for reliable semiconductor supply. TSMC’s new German facility directly serves these clients, reinforcing its ties with regional customers.

In my view, these investments will grant TSMC more market share and solidify partnerships with key tech firms, particularly those involved in AI and HPC applications.

Valuation gap: Why TSMC is a promising semiconductor stock

From a valuation perspective, TSMC appears attractively priced relative to its major competitors, especially given its growth potential, which has yet to be fully reflected in its stock price.

TSMC’s current forward P/E ratio is 28.09, considerably lower than Nvidia’s 49.37, AMD’s 45.27, and Broadcom’s 35.35. This suggests TSMC’s potential as a leader in AI semiconductors remains undervalued. In terms of expected EV/EBITDA ratio, TSMC’s 15.98 is more appealing than Nvidia’s 42.01 and AMD’s 42.61, supporting the argument that TSMC is undervalued compared to peers.

TSMC’s financials reveal intriguing strengths, particularly in its free cash flow (FCF), which has surged by 590.73% year-over-year—a rare feat in the industry. Additionally, the company achieved a gross margin of 54.45%, competitive even if slightly lower than Nvidia’s 75.98%.

TSMC’s ability to maintain high profit margins amidst rising demand and production costs underscores its strong pricing power and operational efficiency. These financial metrics indicate that TSMC not only sustains its current profitability but is also well-positioned for further growth.

The company’s robust financial position supports its global expansion and R&D investments. As of 2024, TSMC’s cash reserves stand at $5.53 billion, far outpacing competitors like Nvidia ($856 million), AMD ($411 million), and ASML ($556 million).

This ample cash flow enables TSMC to strategically invest in expanding manufacturing capabilities, procuring advanced equipment, and advancing R&D, ensuring its long-term competitiveness in semiconductors.

In my view, Nvidia’s reliance on TSMC chips perhaps best illustrates TSMC’s competitive edge. Nvidia’s AI chips, especially those for data centers and autonomous vehicles, are among the world’s most advanced, and TSMC is the only company capable of producing them at the required scale and quality. This dynamic ensures that as Nvidia grows, so does TSMC.

Given TSMC’s growth potential, particularly in AI, I believe the stock is currently undervalued. Investors seeking high-growth opportunities in semiconductors should seriously consider TSMC. TSMC’s cutting-edge process technology, solid financials, and ample cash reserves give it a significant competitive edge in the expanding AI market.

Although the P/E and EV/EBITDA ratios are relatively low, TSMC’s profitability and growth potential make it highly attractive for long-term growth in AI and HPC. Compared to competitors like Nvidia and AMD, TSMC’s undervalued stock offers a rare entry opportunity for investors.

Furthermore, TSMC’s global expansion plans and partnerships with major tech companies reinforce its industry leadership. Despite geopolitical and market risks, TSMC is well-prepared for future growth through its diversified global presence and technological investments.