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Better Chip Stock: Taiwan Semiconductor or Broadcom

The growing demand for semiconductor chips from several industries amid a global supply shortage is pushing up semiconductor prices, helping most manufactures in this space thrive. With renewed initiatives to increase production, we think Taiwan Semiconductor (TSM) and Broadcom (AVGO) are well-positioned to keep benefiting from the industry tailwinds. But let’s find out which of these stocks is a better buy now.

Taiwan Semiconductor Manufacturing Co. Ltd. (TSM) engages in the manufacture, sale and packaging test of integrated circuits and other semiconductor devices, as well as the provision of computer-aided design services. The company serves customers in computer, communications, consumer, and industrial and standard segments worldwide.

Broadcom Inc. (AVGO) designs, develops and supplies a broad range of analog and digital semiconductor connectivity solutions, including wired infrastructure, wireless communications, enterprise storage and industrial and others. The company's products are used in data center networking, home connectivity, broadband access, telecommunications equipment, smartphones and base stations.

The growing application of semiconductors in electronic devices, electric vehicles, and several other segments of the broader technology space, coupled with a global supply shortage, is helping semiconductor companies thrive. Investors’ interest in the semiconductor space is evident in the VanEck Vectors Semiconductor ETF’s (SMH) 40.5% returns compared to the SPDR S&P 500 Trust ETF’s (SPY) 21.5% gains over the past nine months.

Increasing investments in semiconductor chip production should further drive the industry’s growth. The global Semiconductor Integrated Circuit Chip market is expected to grow at a 16.8% CAGR over the next six years to hit $697.23 billion by 2026.

While TSM has lost 9.3% over the past three months, AVGO advanced marginally. In terms of their performance over the past nine months, TSM is a clear winner with 42.8% gains versus AVGO’s 36.7% returns. But, which of these stocks is a better pick now? Let’s find out.

(Recently the Reitmeister Total Return Portfolio (RTR) closed a winning trade in AVGO for a 25% gain. Learn more about the RTR service here.)

Latest Movements

According to a news report by the Nikkan Kogyo newspaper today, the Japanese government wants TSM and Sony Corporation (SONY) to invest ¥1 trillion ($9.2 billion) to build the country's first 20 nanometre chip plant. Japan hopes this investment will boost its semiconductor production to help maintain the production of its domestic companies. However, both the companies have declined to comment on the Japanese government’s desire.

On May 21, TSM introduced a 1-nanometer (nm) semiconductor manufacturing process by using a 2D material with low resistance and high current delivery capabilities in place of silicon. Because SMSN has announced plans to mass-produce 3-nm semiconductors next year, TSM’s 1-nm breakthrough is expected to generate significant sales amid the heightened need for efficiency in performance and battery life.

On May 11, 2021, AVGO introduced the world’s first 64G Fibre Channel Host Bus Adapter (HBA), named Emulex Gen 7 LPe36000-series HBAs. Reducing Database Warehousing Query Time by half, AVGO’s end-to-end 64G SAN technology enabling storage innovation is expected to drive the industry for the next decade.

AVGO and Google Cloud, an Alphabet, Inc. (GOOGL) cloud-computing platform, announced a strategic collaboration on April 13. The collaboration will enhance AVGO’s software solutions in enabling scalability and drive greater operational efficiency. Under this partnership, AVGO will deliver its suite of security and enterprise operations software on Google Cloud, enabling businesses to deploy AVGO solutions in security, DevOps and more on Google Cloud’s trusted, global infrastructure.

Recent Financial Results

TSM’S revenue for its fiscal year 2021 first quarter, ended March 31, 2021, increased 16.7% year-over-year to NT$362.41 billion ($12.92 billion). The company’s gross profit increased 18.1% year-over-year to NT$189.84 billion ($6.77 billion). Its operating income came in at NT$150.54 billion ($5.37 billion), up 17.1% from the prior-year period. While its net income increased 19.4% year-over-year to NT$139.69 billion ($4.98 billion), its EPS increased 19.4% year-over-year to NT$5.39 ($0.19).

For its fiscal year 2021 first quarter, ended January 31, AVGO’s non-GAAP net revenue increased 13.6% year-over-year to $6.66 billion. The company’s gross profit increased 14% year-over-year to $4.88 billion. Its non-GAAP operating income came in at $3.78 billion, up 22.6% from the prior-year period. Its non-GAAP net income increased 25.4% year-over-year to $2.97 billion. Its non-GAAP EPS increased 25.9% year-over-year to $6.61.

Past and Expected Financial Performance

TSM’s revenue and EBIT grew at CAGRs of 11.9% and 14.9%, respectively, over the past three years. The company’s levered free cash flow has increased marginally over the past three years.

Analysts expect TSM’s revenue to increase 25.7% year-over-year for its fiscal year 2021 second quarter (ending June 30, 2021), 22.3% in the current year ending December 31, 2021, and 8.3% in the next fiscal year ending December 31, 2022. Its EPS is expected to increase 16.7% year-over-year for the second quarter, 16.5% for the current year and 15.4% next year. TSM’s EPS is expected to grow at a 15.9% rate per annum over the next five years.

In comparison, AVGO’s revenue and EBIT grew at CAGRs of 9.5% and 17.9%, respectively, over the past three years. The company’s levered free cash flow has increased at a 24.9% CAGR over the past three years.

Analysts expect AVGO’s revenue to rise 13.2% in its fiscal year 2021 third quarter (ending June 30, 2021), 12.5% in the current year ending October 31, 2021, and more than 5% in the next fiscal year, ending October 31, 2022. Its EPS is expected to increase 22.2% year-over-year for the third quarter, 21.5% for the current year, and 7.9% next year. Analysts expect AVGO’s EPS to grow at an 8.6% rate per annum over the next five years.

Profitability

TSM’s trailing-12-month revenue is nearly two times AVGO’s. However, AVGO is more profitable, with a 72.9% gross profit margin compared to TSM’s 53.2%.

Also, AVGO’s 47.4% levered free cash flow margin compares favorably with TSM’s 11%.

Valuation

In terms of its non-GAAP forward P/E, TSM is currently trading at 28.50x, which is 67% higher than AVGO, which is currently trading at 17.07x. AVGO's 1x non-GAAP forward PEG  is significantly lower than TSM’s 1.84x.

Also, in terms of forward EV/sales, TSM’s 9.37x is 14.5% higher than AVGO’s 8.18x.

Thus, AVGO looks more affordable here.

POWR Ratings

While TSM has an overall C rating, which translates to Neutral in our proprietary POWR Ratings system. AVGO has an overall rating of B, which equates to Buy. The POWR Ratings are calculated considering 118 different factors, each weighted to an optimal degree.

Both stocks have a B grade for Quality, which is consistent with their higher-than-industry profitability ratios. In terms of Sentiment, AVGO has been graded a B, which is in sync with the company’s promising revenues and earnings growth outlook. In comparison, TSM’s C Sentiment Grade reflects relatively weak EPS and revenue growth expectations.

Also, AVGO has a B grade for Growth. This is justified because the company’s levered free cash flow increased at a 24.9% CAGR over the past three years. However, TSM has a D grade for Growth. This is justified because its levered free cash flow improved marginally over the past three years.

Of 98 stocks in the B-rated Semiconductor & Wireless Chip industry, TSM is ranked #58, while AVGO is ranked #6.

Beyond what we’ve stated above, our POWR Ratings system has also rated both TSM and AVGO for Momentum, Stability, and Value.

Get all TSM ratings here. Also, click here to see the additional POWR Ratings for AVGO.

The Winner

Given the industry tailwinds, both TSM and AVGO are well-positioned to grow, but AVGO appears to be a better buy based on its relatively lower valuation and better analyst sentiment.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Buy or Strong Buy. Click here to access the top-rated stocks in the Semiconductor & Wireless Chip industry.

Click here to checkout our Semiconductor Industry Report for 2021


TSM shares were unchanged in after-hours trading Wednesday. Year-to-date, TSM has gained 6.70%, versus a 12.45% rise in the benchmark S&P 500 index during the same period.



About the Author: Sweta Vijayan

Sweta is an investment analyst and journalist with a special interest in finding market inefficiencies. She’s passionate about educating investors, so that they may find success in the stock market.

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