Highlights from TSMC's Q1 results

Revenues expected to bottom in Q2 with their latest node ramp-up bringing back growth over H2.

Company & industry profile: TSMC is the leading foundry in semiconductors with a global market share of over 50%. The foundry industry manufactures the chips for the semi designers such as Nvidia, Qualcomm and Marvell. They are largely based in the far east i.e. Taiwan, South-Korea and China.

Q1 Highlights

Revenue in Q1 was down 18% in TWD (16% in USD) quarter on quarter, driven by a weakening macro environment. The 5 nanometer (nm), in red on the chart below, are TSMC’s most advanced production lines i.e. the chips with the highest density of transistors. 7nm, in blue, is one generation earlier.

These two leading nodes make up 51% of revenues:

Drilling down into the revenues, all segments were weak, with the exception of automotive chips, which saw 5% revenue growth quarter on quarter. HPC below stands for ‘high-performance computing’, i.e. chips for datacenters and high-end gaming PCs. The two largest segments, HPC and smartphone, were down 14% and 27% respectively QoQ.

The sell side expect revenues to bottom in Q2, with the company guiding for growth to return in Q3 and Q4 as their new 3nm production lines ramp up, for which they’re seeing demand exceeding their ability to supply. They mentioned they’re doing twice the number of tape-outs at N3 (3nm) as compared to their N5 node. A tape-out basically means that the design process of a chip is complete and volume manufacturing can be started.

However, due to the current uncertain macro environment, I suspect there is room for disappointment, with scope for customer orders being pulled back.

TSMC’s next node beyond 3nm is on track as well - the 2nm is expected to ramp up in 2025, making use of nanosheet transistor technology.

The company is also expanding beyond Taiwan to diversify their manufacturing base. The US fab in Arizona will produce 4nm chips with production expected to start in late 2024. In Japan, TSMC is building a specialty fab with volume production starting around the same period. The company is also engaging with EU authorities to possibly build a European fab focused on automotive chips. As the cost of building fabs outside of Taiwan is higher, a sufficient level of subsidies will be needed in order to proceed. Finally, in China, the company is expanding their 28nm fab in Nanjing. 28nm is a high volume node due to its attractive pricing of chips while providing good performance. However, competition is fierce here as also the second and third tier foundries such as the Chinese fabs compete as this node.

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Gross margins decreased from 62% to 56% quarter on quarter, driven by lower capacity utilization as well as unfavorable exchange rates. The company offset some of this with cost reductions. The sell side is modelling in gross margins to bottom in Q2 with some improvements over Q3 and Q4, as revenue growth returns with the ramping up of the N3 node (3nm). The gross margins beat the guidance of them coming in at 54.5%.

TSMC generates incredible EBIT margins. Even with the current macro weakness, they still came in at 45%:

The company is guiding revenues to decline with low to mid single digits for this year (in percentages). Overall, the sell side expects revenues to be slightly down for the year, so I expect some downgrades will still have to be modelled in shortly. The company is expected to generate solid double-digit revenue growth for the two years thereafter.

Valuation for the company looks attractive at 7x 24’ EBITDA and 11x EBIT, that is, if the macro impact on the company remains limited.. As operating cash flows recover next year, the market is expecting a 4% FCF yield on the EV.

Looking at the PE, the company is currently trading on a NTM PE of 15x, which is roughly inline with its historical average.

Overall, a pretty encouraging outlook for the company. However, the main risk factor will be the short term macro environment. The shares were up 2.3% on the NYSE (ticker: TSM).

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Disclaimer - This article doesn’t constitute investment advice. While I’ve aimed to use accurate and reliable information in writing this, it cannot be guaranteed that all information used is of such nature. The shares’ future performance remains uncertain. The views expressed in this article may change over time without giving notice. Please speak to a financial adviser who can take into account your personal risk profile before making any investment.