TSMC is a foundry that manufactures the world’s most advanced chips, designated by node size. The most advanced node in production today is the 3nm and is primarily used by Apple in iPhones and MacBooks. The 5nm/4nm is used by Nvidia and others for AI accelerators, with high-performance computing quickly moving to 3nm and even 2nm.
Taiwan Semiconductor reported earnings on April 18th. The company topped analyst estimates and its internal guide with revenue growth of 12.9% YoY growth for US$18.9 billion. EPS beat by 4.4% at $1.38 reported compared to $1.32 expected.
Advanced node revenue continues to remain strong, though 3nm revenue dipped sequentially. Per the opening remarks: “3-nanometer process technology contributed 9% of wafer revenue in the first quarter.” This is down from 15% last quarter. The decline is temporary with Trend Force expecting 3nm production capacity utilization to be up 80% by year end. This quarter, revenue from 5nm and 7nm both expanded 2 points.
Despite warning of a slowdown in the broader semiconductor industry this year, TSMC’s April sales surged to NT$236 billion for growth of 60% YoY and 21% MoM. This marks a positive start to the 20-percentage point acceleration to 33% revenue growth that analysts expect as soon as the September quarter.
May sales grew by 30.1% YoY to NT$229.6 billion and June sales grew by 32.9% YoY to NT$207.87 billion, primarily due to the strong demand for AI chips.
We’ve provided an important foundry update on TSMC in early June, which you can find here. Ultimately, we feel obliged to cover TSMC again for our premium members as it’s truly the one that got away from us in H1 2024.
We feel some of the most important work we can do as investors is to look at the stocks that got away from us. The team is continually looking to improve, and thus we present you with an update on the financials as we look for an entry again.
Market Dominance
According to Trend Force research, TSM is the leading global foundry in terms of revenue. It has a market share of 61.7% in Q1 2024, up from 61.2% in Q4 2023. Samsung ranks a distant second with a market share of 11%, down from 11.3% in Q4 2023. SMIC and UMC rank third and fourth with a market share of 5.7%.
Most importantly, the company has over 90% market share in the manufacturing of advanced AI chips.
Financials Update: Strong Q2 Sales due to AI
The company’s June monthly sales grew by 32.9% YoY to NT$207.87 billion. May monthly revenue grew 30.1% YoY to NT$229.6 billion and April monthly revenue grew 59.6% YoY to NT$236 billion. Q2 revenue grew by 40.1% YoY to NT$673.51 billion. In USD, it grew by 32.9% YoY to $20.83 billion using the average exchange rate of 1 US dollar to 32.33 NT dollars. We will get the official USD numbers when the results are announced on July 18th. The monthly numbers suggest that Q2 revenue will easily beat the management guide of $19.6 billion to $20.4 billion. The company is benefiting from the strong demand for Artificial Intelligence chips and a recovery in the PC market.
The company reported its Q1 2024 results on April 18th. Revenue grew 12.9% YoY and down (-3.8%) QoQ to $18.87 billion and beat management guidance of $18 billion to $18.8 billion. The recent quarter showed an acceleration of revenue from a decline of (-1.5%) in the previous quarter. Management guidance for the next quarter is $19.6 billion to $20.4 billion, representing YoY growth of 27.6% at the midpoint.
The analyst consensus estimates are trending higher. They expect revenue to grow 29.8% YoY in the next quarter, up from the 20.6% YoY growth expected in mid-October and are expected to accelerate to 32.7% YoY growth in the September quarter.
Note: The below figures will differ slightly from our reports/the company IR due to the currency conversion. However, we use the estimates below to understand the expected growth rates.
Margins
The Q1 gross margin improved 10 bps sequentially to 53.1%, but it was down 320 bps YoY. The gross margin was down YoY as the company is witnessing higher costs due to the increase in electricity costs and due to a higher contribution from the 3nm node. This is expected, given that TSMC has historically seen headwinds in the initial ramp phase before ultimately realizing higher margins once the node has scaled.
The gross margin guide for the next quarter is 51% to 53%. The gross margin is expected to decline 110 bps sequentially at the mid-point primarily due to the impact of the earthquake on April 03rd in Taiwan and due to another hike in the electricity prices in April this year.
Wendell Huang, CFO of the company, said in the Q1 earnings call, “After last year's 17% electricity price increase from April 1, TSMC's electricity price in Taiwan has increased by another 25% starting April 1 this year. This is expected to take out 70 to 80 basis points from our second quarter gross margin. Looking ahead to the second half of the year, we expect the impact from higher electricity cost to continue and dilute our gross margin by 60 to 70 basis points. We also expect the higher electricity cost to indirectly lead to higher materials, chemical and gases and other variable costs.
In addition, we expect our overall business in the second quarter of the year to be stronger than the first half. And the revenue contribution from 3-nanometer technologies is expected to increase as well, which will dilute our gross margin by 3 to 4 percentage points in second half of '24 as compared to 2 to 3 percentage points in first half of '24.”
The operating margin improved 40 bps sequentially to 42% and was down 350 bps YoY due to the points discussed above. The company is working on tighter cost controls and has helped to reduce operating expenses to 11.1% of revenue in the recent quarter from 11.4% in the December quarter. The operating margin guide for the next quarter is 40% to 42%.
The net margin declined 20 bps sequentially to 38% and down 270 bps YoY. GAAP EPS came at $1.38 compared to $1.31 in the same period last year and beat estimates by 4.4%. The analysts expect GAAP EPS to grow 21.1% YoY to $1.38 in the next quarter and accelerate to 34.1% growth to $1.73 in Q3.
Management is confident of achieving a “long-term gross margin of 53% and higher and sustainable ROE of greater than 25%.”
Due to the economies of scale and its leadership position in the foundry industry, the company maintained good profitability. Many companies have struggled with rising costs, while TSM has successfully navigated these challenges by controlling costs and negotiating better prices with its customers.
Cash Flows and Balance Sheet
The operating cash flow was $13.9 billion or 74% of revenue compared to $12.66 billion or 76% of revenue in the same period last year.
The company’s financial stability is evident in its free cash flow growth, which has more than doubled YoY. Free cash flow was $8.12 billion or 43% of revenue compared to $2.72 billion or 16% of revenue last year. The foundry industry is capital-intensive, and the company is witnessing a stabilization in capital investments that led to higher free cash flow in the recent quarter.
The company has cash and marketable securities of $60 billion and debt of $30.25 billion compared to $54.89 billion and $30.03 billion in the December quarter. The company paid $2.48 billion in cash dividends in the recent quarter.
Advanced Nodes and AI revenue
The Advanced nodes are defined as 7-nanometer and below. We discussed in our recent editorial on the advanced nodes and AI-related revenue reaching fresh records. Most of the AI chips produced by the company utilize 5-nanometer and 4-nanometer process technology. However, 3-nanometer revenue is expected to triple this year. Volume production for 2-nanometer is expected in Q4 of 2025 and should have a meaningful revenue contribution in the first half of 2026.
We mentioned, “Currently, AI accelerators use TSMC’s 5nm process. Nvidia’s Hopper and Blackwell are built with a N4X process that is tailored for high-performance computer applications. This is a customized variant called “4N” that Nvidia uses, yet TSMC recognizes this as 5nm revenue in their earnings report. AI accelerators are expected to quickly move to smaller nodes to help lower power consumption. TSMC’s 3nm process is more energy efficient, and energy efficiency will improve further with the 2nm process.”N4X process that is tailored for high-performance computer applications. This is a customized variant called “4N” that Nvidia uses, yet TSMC recognizes this as 5nm revenue in their earnings report. AI accelerators are expected to quickly move to smaller nodes to help lower power consumption. TSMC’s 3nm process is more energy efficient, and energy efficiency will improve further with the 2nm process.”
Due to its leadership position, management has been optimistic about the long-term opportunity in the manufacturing of AI chips. “In summary, our technology leadership enable TSMC to win business and enables our customer to win business in their end market. Almost all the AI innovators are working with TSMC to address the insatiable AI-related demand for energy-efficient computing power. We forecast the revenue contribution from several AI processors to more than double this year and account for low-teens percent of our total revenue in 2024.Almost all the AI innovators are working with TSMC to address the insatiable AI-related demand for energy-efficient computing power. We forecast the revenue contribution from several AI processors to more than double this year and account for low-teens percent of our total revenue in 2024.
For the next 5 years, we forecast it to grow at 50% CAGR and increase to higher than 20% of our revenue by 2028. Several AI processors are narrowly defined as GPUs, AI accelerators and CPU's performing, training and inference functions and do not include the networking edge or on-device AI. We expect several AI processors to be the strongest driver of our HPC platform growth and the largest contributor in terms of our overall incremental revenue growth in the next several years.”For the next 5 years, we forecast it to grow at 50% CAGR and increase to higher than 20% of our revenue by 2028. Several AI processors are narrowly defined as GPUs, AI accelerators and CPU's performing, training and inference functions and do not include the networking edge or on-device AI. We expect several AI processors to be the strongest driver of our HPC platform growth and the largest contributor in terms of our overall incremental revenue growth in the next several years.”
According to the Commercial Times report, the company is planning to increase the price of 3 nanometer chips by 5% and price of advanced packaging by 10-20% next year. This should help to clear up some of the margin worries caused by the increase in electricity prices and the increased costs of operations of overseas fabs.
Nvidia’s CEO Jensen Huang replied to a question from Morgan Stanley analyst on Nvidia’s opinion on raising prices saying “The price of TSMC's services was too low, and that TSMC's contribution to the world and to the technology industry was not adequately reflected in its financial reports.” It shows the immense pricing power of TSMC.
Its customers Apple, Nvidia, Qualcomm, and AMD have booked the company’s 3nm process technology through 2026 amid the strong demand for AI chips. It further shows TSMC's leadership position in advanced nodes. TrendForce also reported that the company has received new orders from MediaTek and Google for the 3nm advanced chips.
The AI wave has also boosted the company’s advanced packaging business, particularly Chip-on-wafer-on-substrate (CoWoS) services. During the last earnings call, the management also highlighted that the demand for advanced packaging “is high, extremely high. And we do our best to increase the capacity to alleviate the shortage.” TSMC’s monthly CoWoS capacity is expected to expand to 60,000 wafers by the end of next year, up 300% from 15,000 at the end of 2023.
The company’s other advanced packaging technology, system-on-integrated chips (SoIC), is also in robust demand. According to TrendForce, the company is expected to increase the monthly capacity to 5,000 to 6,000 units by the end of this year, up 2.5x to 3x from 2,000 units in 2023. Furthermore, by the end of next year, it is expected to scale to 10,000 units. According to the Economic Daily News, the company has secured Apple as the second major customer of SoIC.
Valuation
The company is trading at a P/E ratio of 35.1 and a forward P/E ratio of 28.9. The P/S ratio is 13.4 and the forward P/S ratio of 11.3. In the last five years, the P/E ratio peaked at 41.8 in February 2021 and hit a low of 10.3 in November 2022. The stock is now trading above its five-year average P/E ratio of 23.7. However, with the expected growth from the increasing contribution of AI revenue and its leadership position in advanced nodes, the market will likely continue to reward with a premium valuation.
Conclusion
TSMC has good long-term revenue growth potential due to its leadership position in advanced technology nodes. The primary catalysts are HPC, particularly AI chips and the recovery in the smartphone market. It has been able to negotiate better prices with its customers, made cost improvements, and maintained strong margins and free cash flows. Here are some technical analysis notes from Portfolio Manager Knox Ridley:
There are times in which Technical Analysis can be quite accurate at nailing lows/highs and managing risk. We use it in conjunction with our outstanding fundamental process to increase our accuracy. However, there are times in which the technicals are at odds with the fundamentals, meaning one is wrong. This is exactly what happened in November of last year, as the technicals sensed risk while the fundamentals did not.
The below chart was posted in November.
The one in red was a 5 wave drop from the June high followed by a 3 wave bounce. More times than not, when we see this setup from a technical perspective, it tends to lead to more downside. This is not what happened, as TSM took the green path higher, and then exceeded it.
We decided to lock in +20% gains in TSM on this bounce, due to technical and geopolitical risk, leaving a lot on the table. This happens in investing, and it has led to the I/O Fund tightening up our process moving forward.
That being said, where TSM is today is much clearer now that we have a solid trend in place.
The near vertical move higher suggests that we are in an unfinished uptrend. This is unfolding as a 5 wave pattern, which still needs at least a 4th wave drop and a 5th wave push higher to complete. This is where the two counts in the chart diverge:
- Red – We are completing the large 3rd wave, should see a sizable 4th wave correction soon, followed by one more large push to new highs.
- Green – We are completing a minor 3rd wave soon. This would be followed by a smaller correction, which would then lead to at least two more swings higher.
Like most 3rd waves, they can continue to extend, which makes identifying a turning point challenging. But, at some point, this 3rd wave will need to correct which is why we plan to buy on a dip rather than a breakout. The best way to handle this is set up a moving support line that will signal the 3rd wave has ended and the 4th wave drop has begun. That level for TSM is $176.
Once we drop below $176, it will signal that the expected correction is underway, and we will setup our buy plan.
Recommended Readings:
- Taiwan Semiconductor Stock: April Sales Soar From Advanced NodesTaiwan Semiconductor Stock: April Sales Soar From Advanced Nodes
- Taiwan Semiconductor Manufacturing (TSM) Deep DiveTaiwan Semiconductor Manufacturing (TSM) Deep Dive
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.