We are expecting the company to confirm a rebound in the second half of the year. Even though 2023 will be a challenging year, the company will continue to grow faster than the industry. The company’s CEO, C.C. Wei, mentioned in the Q4 earnings call, “For the full year of 2023, we forecast the semiconductor market, excluding memory, to decline approximately 4%, while foundry industry is forecast to decline 3%. For TSMC, supported by our strong technology leadership and differentiation, we will continue to expand our customer product portfolio and increase our addressable market and we expect 2023 to be a slight growth year for TSMC in U.S. dollar terms.”
We like TSM as it has developed market leadership in the foundry industry, particularly with advanced nodes, which are nodes defined as 7nm and below. The advanced nodes have strong demand by top design companies, such as Apple and Nvidia, particularly in high-performance computing and smartphones. The company should also benefit from the recent generative AI trend and help withstand any slowdown in the macroeconomy.
Please note: Tensions with China are outside the scope of a fundamental analysis. It’s important to acknowledge that TSMC’s $40B Arizona plant will increase tensions, we prefer to use technical analysis to gauge sentiment around this issue as it’s impossible to predict China’s reaction. We include the price levels we are watching below.
What we are watching:
- H2 rebound confirmation. In the earnings call, C.C. Wei said, “We forecast the semiconductor cycle to bottom sometimes in first half 2023 and to see a healthy recovery in second half this year. In the second half of 2023, we expect our revenue to increase over the same period last year in U.S. dollar terms.”semiconductor cycle to bottom sometimes in first half 2023 and to see a healthy recovery in second half this year. In the second half of 2023, we expect our revenue to increase over the same period last year in U.S. dollar terms.”
- The June quarter is expected to report $16.5 billion and the September quarter is expected to report $19.8 billion. This QoQ growth is important to watch and for the analyst estimates to hold here, particularly, for the H2 rebound.
- The management mentioned in the last earnings call that N7 and N6 chips demand outlook was weaker than expected due to end-market weakness in smartphone and PCs.
- The management updates on 3nm chips. The company expects sizable N3 revenue contribution to start in Q3 and contribute to single-digit percentage to the wafer revenue for the year 2023.
- The margins will be lower in 2023, as the management mentioned in the last earnings call. “We have just guided our first quarter gross margin to be 54.5% at the midpoint mainly due to a lower capacity utilization rate as customers further adjust their inventory levels and a less favorable foreign exchange rate. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, the ramp-up of entry, overseas fab expansion and inflationary cost.” We will look in the call for more insights. The company has leading margins, so it is not a major concern.
Financials
The company reported the March monthly numbers on April 10th. March revenue declined by (15.4%) YoY to NT$145.4 billion. The consolidated Q1 2023 revenue grew by 3.6% YoY to NT$508.63 billion. In US dollar terms, the Q1 2023 revenue comes to approximately $16.74 billion by using the average exchange rate of 1 US dollar to 30.39 NT dollars. (Please note that the company’s official exchange rate could vary slightly). The revenue declined (4.7%) YoY and came at the lower end of the management guidance. We will look for more details when the company reports its results on April 20th.
The weakness in the consumer market could be one of the reasons for the company to report at the lower end of the guidance. According to the preliminary results by IDC, there was a YoY decline of (29%) in the shipments of traditional PCs in Q1 2023 due to weaker demand and excess inventory. IDC expects growth after 2023.
Q4 revenue grew by 26.7% YoY to $19.93 billion. The management revenue guidance for Q1 is $16.7 billion to $17.5 billion, representing a YoY decline of 2.7% at the mid-point of the guidance. The company’s CFO Wendell Huang said in the Q4 earnings call “As overall macroeconomic conditions remain weak, we expect our business to be further impacted by continued end market demand softness and customers’ further inventory adjustment.”
Below is a screenshot of the analyst’s revenue estimates which will vary due to the foreign exchange calculation. We use the estimates to understand the trend and use the company’s IR revenue USD figures in our reports. The analysts expect revenue to grow 1.8% YoY to $17.19 billion in Q1 and to decline (7.7%) YoY to $16.46 billion in Q2.
Source: Seeking Alpha
On a yearly basis the analysts expect revenue to grow 0.8% in 2023, 19.8% in 2024, and 14.7% in 2025.
The adjusted EPS is expected to decline this year and then rebound next year. The analyst expect GAAP EPS of $1.21 for Q1 and $1.11 for Q2.
Source: Seeking Alpha
The gross profit in Q4 came in at $12.4 billion compared to $8.29 billion in the same period last year. Gross profit margin improved to 62.2% from 60.4% in Q3 2022 and 52.7% in Q4 2021. It was higher than the management guidance of 59.5% to 61.5%. It was higher due to cost improvements and favorable foreign exchange rate, partially offset by lower utilization rates. The Q1 2023 management guidance for the gross margin is between 53.5% to 55.5%. The company reported 55.6% in Q1 2022.
The company has industry-leading operating margins. In addition, the company is working on cost improvements and in the past has been able to negotiate better prices with its customers.
Source: YCharts and Company IR
The operating income was $10.36 billion compared to $6.56 billion in the same period last year. Operating margin improved to 52% from 50.6% in Q3 2022 and 41.70% in Q4 2021. It was higher than the management guidance of 49% to 51%. For Q1 2023, the management guidance is between 41.5% to 43.5%. It is lower than the operating margin of 45.6% in Q1 2022.
The management mentioned in the last earnings call, “R&D expenses accounted for 7.2% of our net revenue in 2022. In 2023, as we increase our focus on technology development and add more resources, we expect R&D expenses to increase by about 20% year-on-year and account for 8% to 8.5% of our net revenue.”
In addition, the management also answered to an analyst’s question on the reason for the rise in R&D expenses. “We’re the technology leader, and we intend to continue to maintain the leadership. Therefore, we are devoting more and more resources in R&D, including people and other kind of resource. That’s the reason why our R&D expense will increase in 2023 and probably beyond.”technology leader, and we intend to continue to maintain the leadership. Therefore, we are devoting more and more resources in R&D, including people and other kind of resource. That’s the reason why our R&D expense will increase in 2023 and probably beyond.”
So, we understand that the margins will be lower due to higher R&D expenses along with lower utilization due to inventory adjustments, ramp-up, overseas fab expansion, and inflationary pressures.
The net income was $9.43 billion compared to $5.97 billion in the same period last year. Net profit margin improved to 47.30% from 37.90% in Q4 2021. The EPADR (Earnings per American Depository Receipt) came at $1.82 compared to $1.15 for Q4 2021.
The company has good free cash flow. The free cash flow was $4.78 billion with a free cash flow margin of 24%, compared to a free cash flow of $4.84 billion (free cash flow margin 24%) in Q3 2022 and $5.12 billion (free cash flow margin of 33%) in Q4 2021.
The company has also cut capex for 2023 due to the anticipated slowdown, which is a positive. The company had spent $36.3 billion in capex in 2022 and for the year 2023 it expects between $32 billion to $36 billion.
The company has a stable balance sheet. The company has cash & marketable securities of $50.84 billion and debt of $27.8 billion.
The company is trading at a P/E ratio of 14.10 and is lower than the average five-year P/E ratio of 22.97. The P/S ratio is 6.31 and below its five-year average P/S ratio of 8.4. This is positive that the company is trading below its historical average. The forward P/E ratio is 16.5 and forward P/S ratio is 6.34.
Noteworthy:
Analyst Gokul Hariharan in the Q4 earnings call, asked a question on the outlook for 2023. “Could we have some more color on what is that gives you the confidence for such a strong rebound in the second half of the year to get us back to like a flattish revenue growth for the year?”
The company’s CEO, C.C. Wei, replied, “The inventory correction actually began last year. And at the peak of the third quarter, and we think the inventory has been picked in third quarter last year and gradually reduced in the fourth quarter, and we did see some inventory reduced sharply recently, and it will continue to be so to first half of this year. So that’s why we say we have confidence that in the second half, the business will rebound. But is that a very strong V shape? We didn’t know yet, but certainly, it’s not a U shape for the business to recover in the second half.”But is that a very strong V shape? We didn’t know yet, but certainly, it’s not a U shape for the business to recover in the second half.”
The 3-nanometer process technology is the current most advanced chip production technology. The company is expected to have strong demand in the coming years driven by HPC and smartphone applications. The management mentioned in the earnings call, “Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology, thus, we expect customers a strong demand in 2023, 2024, 2025 and beyond for our 3-nanometer technologies and are confident that our N3 family will be another large and non-large node for TSMC.”we expect customers a strong demand in 2023, 2024, 2025 and beyond for our 3-nanometer technologies and are confident that our N3 family will be another large and non-large node for TSMC.”
Recent Headlines
Nvidia is expected to benefit from the strong demand for Artificial Intelligence chips and the company has recently increased orders for AI chips with TSMC.
DigiTimes reported that Microsoft has approached TSMC to use the company’s CoWoS packaging for its own AI chip.
Apple is expected to use TSMC’s 3nm technology for its first self-made 5G modem chips to be used in iPhone 16 series. Previously, Apple used to purchase 5G modem chips from Qualcomm.
Berkshire Hathaway slashed its stake in the company in February. We have proactively trimmed our position due to geopolitical tensions related to China and due to the Warren Buffet sale.
What Analysts are Saying/Channel Checks
Bernstein analysts highlighted the 1Q23 revenue miss but noted the results still "met the low-end of the guide." The analysts reiterated an Outperform rating on the TSM stock.
KGI Securities resumed coverage of TSMC with an Outperform rating and NT$603 price target. The analysts said that the demand for high-performance computing, fueled by increasing adoption of AI in various applications, has led to a significant increase in silicon dollar content per chip or socket and TSMC stands to benefit.
Bank of America had a positive note on the company due to AI. "We think the generative AI should act as one of the greatest drivers, thanks to the substantial computational requirements for running and training the AI models," the analysts wrote.
"Datacenter (including supercomputing) related revenue currently accounts for ~10% of the revenue, and we estimate that CPU/GPU/accelerator upside for generative AI could potentially contribute 1%-2% initially and likely up to 8% in a bull case," they added.
They also believe there are structural long-term opportunities for the company.
"With rising computing power demand to shorten the time to market and provide better service quality with a faster response time, we believe the pursuit of leading-edge technology will not decelerate. Advanced packaging adoption will also grow. TSMC, with tech leadership in both, will ride on the structural uptrend," they concluded.
Our Plan
The recent escalation between China and Taiwan is something we are monitoring and will use TA to help navigate. This will hit TSM especially hard, but it will have effects on our semis like NVDA and AMD, plus AAPL. We reduced our position in TSM around $87 in late February. We currently hold it in a low allocation in our portfolio, and are targeting better entries. We believe TSM should, at minimum, go back into the $70s, and possibly lower.
Until we get clarity on the path TSM will take, we plan to hedge our current allocation and wait for clarity so that we can get a better entry in this excellent company.
