When Bad Prices Happen to Good Stocks
01/29/2010 3:40 pm EST
Everything is working out exactly as I planned when I bought Taiwan Semiconductor Manufacturing (NYSE: TSM) on October 20, 2009—with the small exception of the share price.
When the company reported fourth quarter 2009 earnings on January 28, it confirmed the two major parts of my investment thesis.
First, a global recovery in the PC, wireless handset, and digital consumer-product markets has started to drive up sales. In the fourth quarter, sales grew by 43% from the fourth quarter of 2008. For 2010, Taiwan Semiconductor forecast a 29% growth rate for the semiconductor foundry industry.
Second, Taiwan Semiconductor’s investment in research and development and in new manufacturing plants has so far distanced the company from its competitors that it sees rising prices and margins for its next-generation chips.
In 2009, TSM worked through problems with electricity leakage in its new 40-nanometer generation of chips that had kept yields low. (In semiconductor manufacturing, how many working chips you get from each piece of silicon is a critical determinant of profit margin. For example, if enough electricity leaks from a chip's circuits—especially in chips that pack transistors extremely tightly together—the manufacturer has no alternative but to throw the chip away.)
Competitors are still struggling with these problems, and that’s given Taiwan Semiconductor an effective market share of 91% in 2009 in the newest and most profitable 40- and 28-nanometer- chip generations, according to Deutsche Bank. And because of the company’s manufacturing and R&D advantages, that share will be 89% in 2010 and 86% in 2011, Deutsche Bank estimates.
The company’s customer list for 40-nanometer chips reads like a who’s who of next-generation technology providers: Intel (Nasdaq: INTC), Qualcomm (Nasdaq: QCOM), Broadcom (Nasdaq: BRCM), Marvell Technology Group (Nasdaq: MRVL), and Nvidia (Nasdaq: NVDA).
That’s a long time to have control of a new chip cycle—and exactly when the profit margins on a chip generation are highest.
The only thing wrong with TSM’s shares is the current correction in the technology sector. Once that’s over—and it will end—I think the stock price is headed up on the fundamentals. See why you want cutting-edge technology stocks in your portfolio to combat the effects of a profitless recovery in this recent post.
As of January 29, I’m upping my target price slightly, to $12.50 a share by May from the former target of $12. (It traded above $10 late Friday.)
Full disclosure: I own shares of Marvell Technology Group, Qualcomm, and Taiwan Semiconductor Manufacturing in my personal portfolio.