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Two Taiwanese chip companies produce a majority of the chips that go into the world’s electronic devices, and one of those is a good buy now, writes Yiannis Mostrous of Global Investment Strategist.

Taiwan Semiconductor Manufacturing (TSM) is the world’s largest semiconductor foundry, with a stable of high-profile clients including Qualcomm (QCOM), Nvidia Corp (NVDA) and Advanced Micro Devices (AMD).

Taiwan Semiconductor Manufacturing will report earnings this week, though the announcement is unlikely to move the stock. The company has already reported third-quarter sales of $3.52 billion, and the market has anticipated decent earnings for the company, though nothing more.

Investors should look to the fourth quarter and the first half of 2012 for developments that will take the company’s stock price decisively higher.

Investors and corporate executives remain worried about macroeconomic uncertainty; they’re likely to adopt a wait-and-see attitude when it comes to making big new orders. As a result, semiconductor inventories should decrease, but they won’t be restocked quickly until decision makers have a clearer sense of the economy’s direction.

In this environment, if Taiwan Semiconductor Manufacturing can tread water—even with a small decline in revenue—the company’s stock will be in a good position to outperform.

Taiwan’s exports grew 9.9% year-over-year in September, up slightly from 7.2% yearly growth reported in August. Imports rose 10.8% on a yearly basis, and the trade surplus came in at $1.8 billion. Exports to mainland China—Taiwan’s biggest overseas market—grew 9.6% year-over-year, while shipments to the US fell 3.8%.

The top five export commodities were: electronic products (up 3% year-over-year), basic metals and articles (up 15.7%), plastics and rubber and articles (up 10.3%), optical and photographic instruments (up 0.8%), and chemicals (up 13%). Shipments of electronics brought in the most money, at $7 billion.

Taiwan is an industrial and technology-focused, export-oriented economy. This means that its export data is a rough barometer of global demand.

The latest data suggests that, although exports were relatively strong, an economic slowdown is brewing. We’ve long argued that a manageable downturn in Asia could be exacerbated by a financial catastrophe stemming from Europe’s sovereign debt crisis and troubles in that region’s banking sector.

Nevertheless, demand for smartphone-, tablet computer- and automobile-related chips remains in relatively good shape, thanks to robust demand from China. The recent “Golden Week” holiday saw strong sales of smartphones and tablet computers, although sales of televisions declined.

But Chinese sales alone can’t offset declining demand in the US and Europe, especially in the television and personal computer segments.

However, new products could act as a catalyst for Taiwan Semiconductor Manufacturing’s business in 2012, namely the 28 nanometer (nm) graphics processing unit (GPU). (A nanometer is one billionth of a meter.) As companies migrate to 28nm chips, semiconductor makers such as Taiwan Semiconductor Manufacturing stand to benefit from this transition.

Programmable logic device maker Xilinx (XLNX) has already said it will switch foundries to Taiwan Semiconductor Manufacturing when Xilinx migrates to 28nm chips. The company previously worked with Taiwan Semiconductor Manufacturing’s rival foundry United Microelectronics Corp (UMC).

Taiwan Semiconductor Manufacturing is also entering the GPU market more dynamically. Advanced Micro Devices started doing business with Taiwan Semiconductor Manufacturing last year, and the two firms are planning to expand their cooperation.

As companies ramp up their use of 28nm chips, Taiwan Semiconductor Manufacturing should see new orders from Japanese integrated device manufacturers (IDM) such as Fujitsu (FJTSY) and Toshiba Corp (Japan: 6502), as Japanese IDMs have apparently decided to outsource the manufacturing of 28nm chips.

Taiwan Semiconductor Manufacturing has reportedly allocated $6 billion toward meeting demand for 28nm chips. This spending isn’t a problem for a company with $4 billion in cash on hand and strong cash flows.

Demand for application processors (AP) for smartphones and tablets should also increase next year. The market has already dissected and forecast sales numbers for Apple’s (AAPL) popular iPad and iPhone.

This means that the real game will be played in non-Apple tablets, and Taiwan Semiconductor Manufacturing produces chips for all non-Apple tablets that use APs. The faster these tablets ramp up in size, the more APs will contribute to Taiwan Semiconductor Manufacturing’s business next year.

Amazon.com’s (AMZN) entry into the tablet space with its new Kindle Fire and the introduction of Microsoft’s (MSFT) Windows 8 operating system should also play a role in boosting Taiwan Semiconductor Manufacturing’s AP business.

The main risks to Taiwan Semiconductor Manufacturing’s business at this point are exogenous, namely that a US recession that will lead to worse-than-expected demand and higher levels of competition.

In regards to valuation, Taiwan Semiconductor Manufacturing’s stock neither trades at its cheapest level nor at its highs. At a little more than three times book value, the shares now trade below the long-term average of 3.7 times price-to-book, with a solid return on equity of 30%. Furthermore, the company has no debt and the stock offers a sustainable dividend yield of 4.2%.

In the universe of technology stocks, Taiwan Semiconductor Manufacturing is a relatively defensive investment—the stock outperforms on the downside and underperforms on the upside. We believe that as the competition intensifies, the company’s size and ability to adapt to new technologies and absorb more orders than its competitors will change this tendency.

Taiwan Semiconductor Manufacturing remains a buy up to $15. [The stock opened Tuesday at $12.48—Editor.]

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Tickers Mentioned: Tickers: TSM, QCOM, NVDA, AMD, XLNX

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