Wedgewood Partners, an investment management firm, published its second quarter 2021 investor letter – a copy of which can be downloaded here. A quarterly portfolio return of 11.8% was recorded by the fund for the first half of 2021, outperforming the S&P 500 that delivered an 8.6% return for the same period, but slightly below the 11.9% gain of Russell 1000 Growth Index. You can view the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Wedgewood Partners, the fund mentioned Taiwan Semiconductor Manufacturing Company Limited (NYSE: TSM), and discussed its stance on the firm. Taiwan Semiconductor Manufacturing Company Limited is a Hsinchu, Taiwan-based semiconductor manufacturing company, that currently has a $600.2 billion market capitalization. TSM delivered a 6.14% return since the beginning of the year, extending its 12-month revenues to 74.31%. The stock closed at $115.74 per share on July 16, 2021.
Here is what Wedgewood Partners has to say about Taiwan Semiconductor Manufacturing Company Limited in its Q2 2021 investor letter:
“We initiated a new position in Taiwan Semiconductor Manufacturing, the largest contract manufacturer of logic semiconductors in the world. The Company has invested prodigious amounts of capital ($17 billion in 2020 alone and as much as $28 billion this year) over the past several years, at returns that suggest to us a very steep and sustainable competitive advantage. The Company has a very long runway to grow its business at a double-digit rate, driven by several favorable industry and company-specific trends including semiconductor architectural design changes, increasing manufacturing process complexity, and the proliferation of more logic semiconductors in more devices.
With over 50% market share, more than 3X that of its next largest competitor, Samsung, the Company dominates the contract foundry industry for logic semiconductors (source: Trendforce). Taiwan Semi has erected a formidable competitive barrier with its manufacturing capacity, as the Company carries over $150 billion in gross PPE (property, plant, and equipment) on its balance sheet. This would put the Company in the top echelons of invested tangible capital, globally. Further, the Company has committed to a multi-year, $100 billion capital investment program aimed at building out some of the only capacity capable of manufacturing leading-edge, sub 7 nanometers (nm) resolution integrated circuits. While semiconductor cycles are notoriously boom-bust, the Company has already secured enough demand to drive very high utilization rates for this new bleeding-edge capacity much earlier compared to previous capacity rollouts.
There are several reasons for higher sustained utilization this time around. First, integrated circuits have become extremely complex to manufacture. The Company has secured the majority of the precious few extreme ultraviolet (EUV) tools that enable the manufacture at resolutions that are substantially smaller than the wavelength of light. The Company has invested in and works very closely (on-site) with EUV tool makers to develop this technology. As a result, there is less available capacity from competitors as compared to previous cycles. Second, due to this complexity, chip developers are radically changing their
architectural designs, pushing more demand to the likes of Taiwan Semi that would otherwise be kept in-house. For example, one large customer, AMD, has had a lot of success taking CPU market share from Intel by architecting chips that have disaggregated several functions into smaller dies. Intel has recently launched a similar architectural change, but it will require it to utilize the Company’s sub-7nm capabilities, as Intel does not yet have an economic way to produce these nodes, in-house. Third, the overall demand for more computing power continues to grow as applications related to artificial intelligence require
this, and the availability of hardware instances via public cloud providers enables individuals to access a couple, a dozen, or even hundreds of processors at once. This is vastly different compared to the user-PC-server dynamic of previous cycles. Last, as has been widely reported, older, “trailing node” foundry capacity has been in short supply. These shortages have little to do with the Company’s leading-edge investments right now, as less than 40% of their revenues are derived from nodes larger than 28nm. However, we expect their current leading edge to eventually become “trailing-node.” As these smaller nodes proliferate over time, we expect fewer chip manufacturers will be capable of generating manufacturing yields that justify capital investment, driving up the long-term utilization and pricing power of the Company’s installed capacity.Over the next several years, we expect Taiwan Semi to generate percentages of compounded revenue growth in the mid-teens along with higher margins and returns, driven by their scarce capacity in leading-edge logic manufacturing. Though the stock trades at a slight premium to the market, we think it is much more reasonable compared to where it traded earlier this year. In fact, the stock briefly went through a bear market earlier this year – after which we began purchasing shares. As the market might periodically serve up shares due to cycle-ending fears, we will look to add to our holding as the Company should be able to sustain superior growth and returns longer than previous cycles.”
Photo by Umberto on Unsplash
Based on our calculations, Taiwan Semiconductor Manufacturing Company Limited (NYSE: TSM) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. Taiwan Semiconductor Manufacturing Company Limited was in 76 hedge fund portfolios at the end of the first quarter of 2021, compared to 72 funds in the fourth quarter of 2020. TSM delivered a -2.61% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
