As 2022 dawned, shares ofTaiwan SemiconductorManufacturing Company Limited(NYSE:TSM) reached a 52-week high of $145. Starting in mid-January, the stock tumbled for nearly six months before hitting a year-to-date low of roughly $74.
Record revenue in Q1, followed by a strong second quarter, resulted in a lackluster boost in the share price.
Lost among concerns that TSM operates in a cyclical industry, the ever-present threat mainland China presents, and customer's increasing inventories, is the preeminent position TSM holds in the semiconductor industry.
TSM is a veritable poster child for a wide moat business. As such, it commands hefty margins and has a long growth runway.
TSMC's Quarterly Results Speak Volumes
Back in April, TSM reported record revenue for the month of March of $5.94 billion, up 35% year-over-year. Revenue for the entire quarter stood at $16.97 billion, a 35.5% increase from the comparable quarter.
Q2 results, reported in the middle of last month, beat on the top and bottom line. Revenue was up year-over-year by 36.6% to $18.16 billion. Net income and diluted EPS both increased by 76.4%, year-over-year. Revenue increased 8.8% and net income grew 16.9% relative to Q1 '22.
Operating margin of 49.1% beat the upper end of management's guidance by more than 2%. Gross margin for the quarter was 59.1%, and net profit margin was 44.4%.
TSM recorded increased demand in every product category, with HPC, IoT and Automotive all witnessing double digit growth.
Had management provided weak guidance or expressed concerns regarding demand going forward, I'd be better able to wrap my head around the marked drop in the share price.
The fact is that TSM forecasts margins in the latter half of the year to largely be in line with the latest results. At the same time, revenue is forecast in a range of $19.8 billion to $20.6 billion in Q3, a significant jump from previous quarters.
Management also guides for sustainable annual sales growth of 15%-20%, which is about double its earlier target range.
So I must ask the question: what do the bears see that I might be missing?
A Bear's Perspective
An understandable concern is the cyclical nature of the semiconductor market. Add to that the swollen inventories of some customers now that COVID related surges in demand are waning.
In particular, PC demand is down and smartphone shipments are shrinking, in part due to supply chain disruptions. Smartphones generate 38% of TSM's total revenue, so a significant drop in demand would undoubtedly weigh on the stock.
TSM reported a 3% increase in smartphone revenues in Q2. During theearnings call, an analyst posed a question regarding inventory levels related to smartphones:
Yes, yes. So how about the high-end smartphone inventory correction? Do you expect that top brand inventory -- smartphone inventory to see correction as well on the semiconductor demand? Thank you.
To be frank with you,we did not see too much of inventory on the high-end smartphone buildup. So no.
C. C. Wei, CEO
Apple (AAPL) is TSM's largest customer by a wide margin. Therefore, investors need to monitor that firm's smartphone sales closely.
During Apple's last earnings call, management stated that the company set a June quarter record for both revenue and consumers switching to iPhones. Despite foreign exchange headwinds, iPhone revenue grew 3% year-over-year to a June quarter record of $40.7 billion.
Apple also set June quarter records in both developed and emerging markets. Management also noted there was no obvious evidence of macroeconomic impact during the June quarter.
Another major concern is bloated inventory levels. Many of TSM's customers over-ordered in an effort to adjust for a lack of global semiconductor supply. Once again, I will turn to an exchange between an analyst and management during the last earnings call:
When I look at your customers, their inventories are at a 25-year high. And I think everyone is going to take a look at the seasonality in the second half. And I'm just curious, what are the key variables? What are the key metrics? Or what are the key strategies that you have in place that could mitigate the gross margin balance by this if your customers become more aggressive in inventory correction into next year?
Well, let me answer the question. As I stated in the remark, our customers are doing the inventory correction. But I said that customer demand still exceeds TSMC's capability to support for this year. So even they do the inventory adjustment, what I say that they decrease their demand versus their original number,TSMC's capacity is still very tight and will remain very healthy in the utilization. So that's why we can keep our gross margin intact. Did I answer your question?
C. C. Wei, CEO
Management provided additional color regarding inventory levels.
On the demand side, while we observe softness in consumer end market segment, the end market segments such as data center and automotive-related remains steady. And we are able to reallocate our capacity to support these areas. Despite the ongoing inventory correction,our customers' demand continues to exceed our ability to supply.We expect our capacity to remain tight throughout 2022 and our full year growth to be mid-30% in U.S. dollar terms.
C. C. Wei, CEO
The threat of a military conflict between Taiwan and mainland China leaves some investors on the sidelines. My response to that scenario is as follows:
In my lifetime, there is either a zero percent chance or a 100% chance of China invading Taiwan.
Moreover, an argument can be made that the loss of TSM would cripple a number of fabless semiconductor companies. At the end of2021, Apple accounted for a quarter of TSM's revenue. Add Qualcomm (QCOM), Advanced Micro Devices (AMD), and Nvidia (NVDA) to a long list of companies that rely on TSM to produce their semiconductors.
Should I eschew an investment in those four stocks (and others) due to their exposure to TSM/China risk?
Where We Will See Growth
We reiterate our long-term revenue to be between 15% and 20% CAGR over the next several years in U.S. dollar terms. (Q2 Earnings Call)
Demand for high-performance computing (HPC) increased by 13% in Q2 and represented 43% of revenue.
MarketsandMarkets forecasts a 6.7% CAGR for the HPC market through 2027.
Mordor Intelligence has a more robustforecastfor the HPC market, projecting a CAGR of 9.44% from 2021 - 2026.
Mordor Intelligence alsoforecastsa CAGR of 14.98% through 2026 for the global IoT Chip Market. In Q2, IoT comprised 8% of TSM's revenue.
Automotive provided 5% of revenue last quarter. Transparency Market Research forecasts aCAGRof 7.63% through 2031 for the global automotive chip market.
However, there are more sanguineprojectionsfor the global automotive chip industry with forecasts of a CAGR of 10.8% from 2021 to 2030.
These forecasts are bolstered by the recent claim by General Motors (GM)CEOMary Barra that the automotive chip shortage will continue into 2023.
Furthermore, the current drag in demand for smartphones is likely short lived. The smartphone market is projected to experience aCAGRof 6.85% through 2027.
TSM is building a $12 billion plant in Arizona and a $8.6 billion facility in Japan to meet the expected surge in demand. This is part of the company's projected three year, $100 billion in capex devoted to increasing chip capacity.$Taiwan Semiconductor Manufacturing(TSM)$
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