The following article was written by Robert Silgardo, Analyst, based on his trip to Taiwan earlier this year. Please see important disclosures at the end.
Earlier this year, I spent a week in Taiwan and met with over 20 companies within the Asian technology supply chain. Economic activity, day-to-day life, and sentiment among citizens and corporate executives are largely back to normal. Most COVID restrictions and policies have been lifted, but many locals (especially those in the service industry) still wear masks, and everyone is required to mask up on public transit (including the high-speed rail). Concerns about a potential Chinese invasion, slower-than-expected demand recovery, and ongoing talent shortages were topics of discussion during many meetings with company executives.
We observed several key themes with important implications for investors:
- The Chinese threat to Taiwan is top of mind
- Inventory supply has improved, but demand concerns persist
- Engineering talent comes at a premium
- Taiwan continues to lead in social responsibility
- Opportunities exist beyond TSMC
Cross-strait Tensions Remain Front Page News
The Chinese threat to Taiwan is featured on the front page of local newspapers, with the media focusing on Chinese military investments. Sentiment is mixed, with older generations less concerned about an invasion (as they have lived with the situation for many years), while younger generations express much more concern. Some Taiwanese Americans I spoke with are trying to secure US passports for their children to help them be prioritized for evacuation in case of an invasion. Foreign companies are developing contingency and business continuity policies. These actions are all new, as there was no discussion about this threat when I last visited Taiwan in 2019. The probability of an imminent Chinese invasion remains low, but we believe geopolitics will continue to be an overhang for the region.
Inventory Correction is Underway, but Demand Worries Persist
Taiwanese companies believe the ongoing inventory correction should end by mid-2023. I was encouraged to hear that inventory levels are improving, especially in consumer electronics and PCs. Two of our holdings, Parade Technologies and Tripod Technology, have sizable PC industry exposure and should benefit. On the contrary, data centers and servers face elevated inventory levels – a change for these previously more resilient technology sub-sectors. Our holding Delta Electronics (a data center power management company) could be negatively impacted in the second half of this year.
A bright spot is AI; order volumes among AI-related supply chain companies are recovering more quickly than their traditional counterparts due to heavy investment in the supporting infrastructure by US tech giants. Contacts at our holdings Chroma ATE (a power test equipment vendor) and Delta Electronics confirmed this view.
A common concern in many meetings was the demand recovery waning in the second half of the year. China’s post-reopening economic recovery continues to disappoint, particularly in electronics demand. This trend, combined with elongated replacement cycles, means the world’s largest handset market will likely see tepid shipment growth. Following our trip, demand concerns have also risen within the Apple supply chain, particularly in China. We are closely monitoring the situation, as it could affect our holdings Hon Hai and Zhen Ding, both of which are large Apple suppliers.
The consumer electronics industry (smartphones, PCs, TVs) enjoyed supercharged growth during the pandemic years (early 2020 through the first half of 2022). As the global economy slows, our base case assumption is for a modest recovery in consumer electronics demand.
“We Need More Engineers”
Engineering talent is in high demand, but there is increasingly limited supply. Our contacts indicated that TSMC’s aggressive hiring pace is causing other companies to be priced out of the market for quality talent. Beyond Taiwan, there is a global shortage of engineering talent. According to one report[1], the semiconductor talent gap in China could grow to more than 200,000 people in 2023. We are carefully monitoring this situation, as persistent challenges could create secular margin headwinds.
Within EM, Taiwan is at the Forefront of ESG
Taiwan has always been an eco-friendly society, and Taiwanese companies have been at the forefront of ESG even before the label was created. In the 2023 Morningstar ESG rankings, Taiwan moved into fifth place globally, up from eleventh last year. Traveling through the countryside reinforced that view, as I noticed rural areas flush with micro-farms. It reminded me of stories shared by some Taiwanese companies, including Advantech, which actively encouraged employees to farm and grow their own produce by providing them with small plots of land. This type of corporate action fosters a culture of eco-friendliness and sustainability among employees and promotes a healthy lifestyle.
A Fertile Hunting Ground
Taiwan is a fertile hunting ground for technology investors. Taiwanese companies have strong engineering heritages coupled with balance sheet discipline. This combination frequently enables companies to generate consistent financial productivity over the long term, which is consistent with the long-term investment thesis for our Taiwanese holdings. Our holdings provide a range of exposure from cyclically defensive business models (Tripod Technology) to secular growth opportunities (Chroma ATE, Delta Electronics, Parade Technologies). We believe our holdings are well-positioned and can handle the ongoing concerns identified during my recent trip.
We look forward to our next trip to the island famous for its xiaolongbao, night markets, pineapple cakes, and – oh yes – technology leadership.
[1] Source: China Integrated Circuit Industry Talent Development Report (2020-21 edition), https://intelligence.weforum.org/monitor/latest-knowledge/3767c743b2e2487db4f191cb71aca687.
