Taiwan Semiconductor Is at a Trough Due to Global Chip Shortage

• Taiwan Semiconductor (TSM), the largest semiconductor chip maker, is at a trough
• This is despite the world market experiencing a massive chip shortage — which normally indicate TSMC stock would peak
• Expect TSMC stock to move higher as the effects of the chip shortage continue to multiply through the global economy.

Taiwan Semiconductor Manufacturing Inc. (NYSE:TSM) has been falling lately. As of Tuesday, TSMC stock closed at $107.04, down from a recent peak of $140.66 on Jan. 14. That represents a drop of 23.9% from it peak.

Moreover, year-to-date (YTD) TSMC stock is off 9% down from $120.31 from Dec. 31. It’s almost as if the market thinks that there is no chip shortage and that the stock is overvalued.

That could not be further from the truth. As a result, expect to see Taiwan Semiconductor stock rebound to its further heights and more.

What to Expect at Taiwan Semiconductor Manufacturing

I like to cut to the chase. TSMC produced $9.771 billion in free cash flow (FCF) last year, based on its own dollar/New Taiwan Dollar (NTD) exchange rates. This is from my calculations per the information on page 4 of its financial statement — not anything in their earnings release. (You can probably tell I don’t like to rely on company statements).

This represents a very respectable 17.2% of its $56.8 billion in revenue last year. That is pretty good, but the lead is buried in the details.

From what I can tell (using the NTD data), the chip maker produced a 32.55% FCF margin in the fourth quarter. This was almost twice the rate for the full year. That likely reflects the premium pricing it is now able to charge and bodes extremely well for 2022.

In fact, the company provides guidance of 5.3% to 9.3% increase in revenue for Q1 on its investor relations website.

More importantly, it reports that its guidance is for an operating margin of 42% to 44%. Last quarter it beat its own guidance of a 39% to 41% operating margin guidance, achieving a 41.7% operation margin.

Estimating its 2022 FCF

So, do you see the pattern here? We can estimate its Q1 free cash flow by assuming that the relationship between operational margin and FCF margin in Q4 holds up. For example, its Q4 FCF margin was 32.55%, and the op margin was 41.7% — i.e., the FCF/Op Margin ratio is 78.1%.

This means that we can assume that the Q1 FCF margin will be 71.8% of its new guidance of 42% to 44% for Q1. That means FCF will be 30.9%. This is slightly less than the 32.55% Q4 margin, but we can assume that it will last throughout 2022. Therefore, using analysts’ 2022 revenue forecast of $72.68 billion in revenue in 2022, its FCF will be $22.46 billion this year.

That implies a huge gain in the stock price is coming. Here is why.

Where This Leaves TSMC Stock

Right now the stock is valued at about a 1.75% FCF yield (i.e., $9.77 billion in FCF / $555 billion market capitalization). Therefore, if we divide our $22.46 billion FCF estimate by the 1.75 FCF yield metric, the target market value is $1,386 billion (i.e., $1.386 trillion). That represents a potential gain of 150% in the stock price.

In other words, theoretically TSM stock could be worth 2.5x the price today if we use the same 1.75% FCF yield metric. But just to be conservative, let’s assume the market will not do this, but use a higher 2.5% FCF yield. That still brings a potential market cap of $978 million, or 96% over today’s price.

In other words, TSM is worth 1.96 x $107.04, or $209.80. That is all if the company’s FCF margins rise from 17% last year to about 31% this year. I suspect the market is slowly starting to realize this and will adjust the price soon. After all, that is only 49% over its previous peak – so it does not seem so unthinkable.

The bottom line here is that investors should expect a major turnaround in TSM stock. After all, we are in a major chip shortage and the stock does not seem to adequately reflect this.

On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.