Semiconductor Industry: Amkor Technology's Outlook and TSMC's Growth Prospects

Amkor Technology: Weak Near-Term Guidance Has Created A Buying Opportunity Post-Q2

While valuation has crept upwards in recent years, Amkor is poised to benefit from long-term on-shoring trends as they diversify their manufacturing capacity. Amkor Technology (NASDAQ:AMKR) just released its Q2'24 results and guidance came in lighter than expected. However, given an 18% drop in shares, I believe shares offer compelling value given Amkor's strong market position in the outsourced assembly and test manufacturing market and its differentiated portfolio of advanced packaging solutions. In my view, the company is well-positioned to intercept the strong underlying demand trends in semiconductor and the technology transition towards more advanced packaging. It's likely that Amkor can capture more value in the manufacturing supply chain over time on new packaging innovation/complexities. At the current valuation, the recent share price decline has provided investors an opportunity to buy a company that's gaining share with its largest customers, benefiting from the trend to outsource manufacturing capacity. Amkor technology is the second largest outsourced assembly and test supplier and is headquartered in the US. The company's focus is on advanced packaging solutions (three quarters of revenues), which are faster growing and more profitable given their higher-value added services. Amkor has a leadership profile in advanced packaging, which is used across mobile devices, automotive/industrial, datacenter, and PC/consumer end applications. Amkor generated $6.5 billion in revenues for 2023, and has been delivering a high-single-digit revenue CAGR over the last several years. Major customers include Apple (AAPL), QUALCOMM (QCOM), Skyworks (SWKS), NVIDIA (NVDA), and NXP (NXPI), among others. With EPS of $0.27, this was 3 cents higher than last quarter sequentially and 1 cent higher than Q2 last year. On operating income, margins continued to expand both on a sequential and year over year basis, with operating margins now sitting at 5.6%. Capex forecast for the year remains at $750 million, unchanged, and will be used on increasing advanced packaging capacity for 2.5D and advanced SiP as well as expanding select manufacturing facilities. In my view, the resulting share price reaction was way overblown. Comparing the midpoint of the guidance range to consensus estimates heading into the quarter, Amkor's guidance was just 1% off. Before we get into the outlook, I think it's helpful to get into the latest quarter. In Q2'24, Amkor's results were driven by Advanced packaging supporting premium tier smartphones and AI solutions utilizing 2.5D technology. In particular, the demand stemming from the Communications and Computing end markets was particularly strong; however, gains here were partially offset by weaker demand in addition to ongoing inventory corrections in the Automotive & Industrial and Consumer end markets. The Communications segment includes smartphones and tablets. The company has broad penetration in the applications used for the smartphone market, including RF front end, sub-6 Ghz & mmWave, sensors, storage, wireless charging, baseband, apps processor, and sub-systems processor. Higher performance requirements, expanded features, and increasing power consumptions are driving greater miniaturization and higher levels of integration, all of which are enabled by advanced packaging. Customers include Apple, Qualcomm, Qorvo, Skyworks, among many others. For the smartphone market, I think we could finally start to see unit growth recover in 2024 after six years of decline, led by a strong refresh cycle tied to AI smartphones. In Q1'24, the global smartphone market grew 6% year over year to reach 296.9 million unit shipments, so this alone is a positive key indicator. One important development during the quarter was that the company has now established a U.S. manufacturing facility for advanced packaging. Given that they've got a nonbinding preliminary memorandum of terms with the US Department of Commerce for up to $400 million in grants under the CHIPS and Science Act, it seems that the government is very supportive. Over the last few years, amidst global tension (particularly with China and Taiwan), there has been a strong push by governments and companies for more geographical diversification due to a number of concerns that span from geopolitics to potential disruptions from natural disasters. Given strong industry investments augmented by govt chip subsidies (e.g., US CHIPS and Europe), fab capacity outside of Taiwan/China is expected to increase substantially. For example, in the US and Europe, fab capacity is expected to increase by 200%+ and 125%, respectively, over the next decade With Amkor's strategy to diversify manufacturing capacity in several countries (the U.S. and Vietnam), Amkor is well-positioned for the semiconductor on-shoring trend with global manufacturing operations across the US, Europe, and Asia, is well-positioned for this semiconductor on-shoring trend. From a balance sheet perspective, Amkor had cash and cash equivalents of $1.5 billion at the end of the quarter, with liquidity of $2.2 billion that gives the company flexibility to invest in capacity and technology. On leverage, the company has $1.1 billion in total debt, for a Total Debt to EBITDA ratio of 1.0x. Given cash greater than debt, the leverage here is very modest, and is down from 2019 levels. In terms of the risks to the investment thesis, the main ones would be a slowdown in the global economy, which could potentially stop demand trends out of the broader semiconductor recovery. Another risk would be a company-specific risk, where Amkor is unable to execute on its 2.5D advanced packaging capacity expansion or if AI infrastructure build-out slows. Lastly, supply chain disruptions either by suppliers or government regulation and intervention would hamper manufacturing abilities, which would almost certainly have a determinantal impact on both the top and bottom line. Based on the 8 sellside analysts who cover Amkor's stock, there are 5 'buy' ratings and 3 'hold' ratings. The average price target is $42.63, with a high target of $55.00 and a low target of $35.00. From the current price to the average price target one year out, this implies about 36.9% upside, not including the 0.8% dividend yield. Given strong upside potential, analysts seem to be quite bullish on Amkor's near-term outlook. In my view, Amkor is worthy of a valuation re-rating. At 7.6x EV/EBITDA, Amkor's valuation is close to the most expensive they've ever been, above the historical ten-year average of 4.2x EV/EBTIDA (source: S&P Capital IQ). In my view, this is justified given the dynamics at play with on-shoring and the developments with AI. With a cyclical recovery underway for the semiconductor industry, combined with powerful long-term growth trends, I believe there's an opportunity, even with the elevated valuation. Looking at consensus EPS estimates for the next few years, analysts are projecting that Amkor can grow EPS from $1.46 in 2023 to $3.20 by 2026 (source: Bloomberg). So with a macro trend for an industry recovery, outsourcing continuing to be a secular trend, and better diversification across its geographic facilities, Amkor's shares look enticing. As such, given the drop in shares post-Q2 results, I'd be a buyer of shares at current levels.

TSMC: Multiple Growth Drivers Ahead (NYSE:TSM)

TSMC (NYSE:TSM) recently reported its 2Q24 results and I joined in for the earnings call. Before I jump in on the earnings results, I thought I would first comment on the earnings call. In my opinion, the mood on the earnings call was much more jovial compared to prior earnings call and CEO Wei also sounded more energetic than he did before. In fact, TSMC CEO Wei even tried to be funny by saying Nvidia (NVDA) CEO Jensen's tagline and changing it for TSMC: "The more TSMC wafers you buy, the more you save." While the mood in the earnings call may not be quantitative evidence, it does provide qualitative evidence that TSMC's business might, in fact, be booming and that good times are ahead. I have written extensively about TSMC stock on Seeking Alpha, which can be found here. TSMC published 2Q24 results that exceeded the top end of its guidance. Earlier in July, TSMC reported 2Q24 revenues of NT$673.5 billion, which was up 40% from the prior year and up 14% sequentially. This beat the high end of its own guidance and consensus expectations by 2% to 3%. By technology, TSMC's N3 process contributed 15% of wafer revenue, and this is the most advanced in production today. In fact, revenues from TSMC's N3 almost doubled from the previous 3-month period. The N3 customers are actually not Nvidia. These important N3 customers are Apple, Qualcomm and AMD. The high performance computing ("HPC") segment is the most important segment for TSMC today. This is essentially the AI segment for TSMC. It makes up 52% of TSMC's net revenues. The HPC segment grew very strong, which was up 28% sequentially. Another important segment for TSMC is the smartphone segment. Smartphones make up 33% of revenues, but in the 2Q24 quarter, was down 1% sequentially. From the margins and profitability side of things, TSMC also managed to beat expectations. TSMC's 2Q24 gross margin came in at 53.2%, beating consensus estimates of 52.6% and came in above the long-term goal of a consistent 53%. TSMC's 2Q24 operating margin came in at 42.5%, beating consensus estimates of 41.6%. TSMC's 2Q24 net income came in at NT $247.8 billion, compared to consensus expectations of NT $235 billion, beating consensus by almost 6%. Capital expenditures for the first half of 2024 came in at $12.13 billion. This implies that it will need to ramp up capital expenditures in the second half of 2024 to meet its capital expenditure guidance. TSMC expects 3Q sales to be driven by structural demand from AI and cyclical upturn demand from smartphones. 3Q24 gross margin is expected to be between 53.5% to 55.5%, and 3Q24 operating margin is expected to be between 42.5% to 44.5%, which beat consensus expectations of 52.5% gross margin and 42.1% operating margin respectively. TSMC raised the 2024 guidance above mid 20% in USD terms. The capital expenditure guidance range for 2024 was increased. The initial range of between $28 billion and $30 billion was increased to the new range of between $30 and $32 billion. 70% to 80% of this capital expenditure will be used for advanced technologies. TSMC provided solid commentary about smartphone demand. TSMC CEO Wei said: "We expect our business to be supported by strong smartphone and AI-related demand for our leading-edge process technologies." He expects smartphone-related demand to be one of the growth drivers for TSMC in the second half of the year. Within smartphones, with AI requiring more silicon content, with 5% to 10% die size increase in general, AI will provide structural growth opportunity for TSMC. TSMC is also seeing more smartphone clients are moving to advanced packaging like InFO packaging. TSMC has long maintained that pricing is strategic, and never opportunistic. TSMC stated that pricing is an ongoing and continuous process. The company is likely in negotiations with key customers to increase prices in some key products. TSMC CEO Wei said that: "My customers are doing very well, and we should do as well". Apart from the fact that its customers like Nvidia are doing well, and that there is very strong demand that the supply cannot catch up to, TSMC also mentioned some cost reasons that may help with its price hikes. Specifically, TSMC mentioned that their costs are rising due to international expansion and high-power prices in Taiwan. While there is rising concern over geopolitical tension given the upcoming US presidential election, TSMC mentioned that it would continue its overseas expansion to mitigate the risks. This includes the new fabs ramp in the US and Japan the next year and diversifying production locations. TSMC also reported government subsidies in the cash flow statement and balance sheet. If there is any tariff and trade policies, that will be paid by their customers, according to TSMC. This is definitely good news for TSMC given that any tariffs imposed could lead to customers paying the extra and given that most of TSMC's customers are based in the US, US companies end up paying the tariffs on behalf of TSMC. I think this quarter's report shows that with a strong market position, TSMC is in a favorable position in terms of pricing power, which helps with the long-term gross margins. With strong pricing power, TSMC expects that its long-term gross margin is expected to be 53% and higher. In fact, TSMC CEO Wei even emphasized on the "and higher" and he stated: When I have discussions with my customers, I will give the "and higher portion". Despite potential challenges from geological tensions or higher operating costs due to inflation, rising electricity costs and overseas capacity ramp-up, TSMC remains optimistic that it can achieve gross margin of 53% and higher. This is a result of TSMC's superior performance and efficiency of its products, which helps justify a premium pricing and this will also help with its long-term profitability. In short, TSMC needs to ensure it maintains this superior performance and efficiency, if not this margin and profitability profile could deteriorate. As mentioned in the prior section, TSMC needs to maintain a superior performance and efficiency level to be able to maintain its profitability. With that, TSMC is growing its leadership within foundry, and adding to the much needed CoWoS capacity that is current in short of supply. TSMC stated that for its N2 fabrication process, which is for its 2nm technology, the initial ramp up will be stronger than previous nodes like 3nm. When asked about the progress about TSMC's next two fabrication nodes N2 and A16, CEO Wei said that "almost all the AI innovators are working with TSMC." "He expects to have more N2 customers than for N3 and N5 and everything is going ahead of schedule with A16 development." As a result of better performance of scale, this has a positive impact on margin dilution, which will be less than what we saw with N2. Another thing TSMC has been focused on is increasing the supply for CoWoS advanced packaging, which is essential to AI accelerators like Nvidia. TSMC states that demand is very strong and that the company is working hard to meet this strong demand. The goal here is to continue to increase supply, although TSMC expects supply to continue to be "very, very tight" all the way into 2025. That said, TSMC is aiming to reach a balance sometime in 2025 or 2026 for the CoWoS supply and demand situation. TSMC expects CoWoS capacity to be more than double from the prior year in 2024. In turn, management expects growing AI demand to support its accelerated CoWoS expansion into the next one to two years. TSMC highlighted in the earnings call the role of AI in driving demand and sees AI as a long-term growth trend, not just for TSMC, but for the semiconductor industry. Below, I share my 5-year financial forecasts for TSMC. The revenue CAGR over the next 5-year period is 17% while EPS CAGR is slightly higher at 19%. I use the free cash flow to equity derived from the financial forecasts for the intrinsic value calculation. My intrinsic value for TSMC is $184. This is based on the assumption of 21x terminal multiple and 12% cost of equity. TSMC's 5-year average multiple is 23x, so I think giving a 20x terminal multiple is reasonable given the slower growth profile in the outer years. I would buy TSMC at $147, or at a 20% discount to its intrinsic value. My 1-year and 3-year price targets for TSMC are $228 and $302 respectively, which implies 25x 2025 and 25x 2027 P/E respectively. At a time when the theme is rotation out of technology stocks and when AI has been likened to a bubble, TSMC's business continue to shine and exceed expectations. Strong demand for high performance computing, or AI, drove the bulk of the growth we saw in revenues for 2Q24, which is driven by strong structural demand from AI. In the second half of 2024, apart from this structural AI demand, we will also see cyclical demand from smartphones as a result of an upcycle. While revenue growth is great, when combined with growing margins, this cocktail of revenue growth and expanding margins is a very strong stock price mover. Margins for TSMC are expected to be strong as a result of its dominant market position, superior performance and efficiency, which is driving pricing power and the ability to raise prices. In addition, TSMC is not stopping there. The company continues to extend its lead over competitors to ensure that its margin and profitability profile can be maintained.