To The Moon

$Taiwan Semiconductor Manufacturing(TSM)$ just reported impressive sales figures and is set to release its Q3 earnings this week. As a leading player in chip manufacturing, TSMC remains one of the biggest beneficiaries of the AI boom, thanks to growth from NVIDIA and other companies.

Earnings and Forecast

While we await TSMC's earnings, cash flow, and outlook for Q4, Wall Street analysts project Q3 earnings per share (EPS) to be around $1.79. This would represent a 39% increase year-over-year, with revenue also expected to rise by 30%. Analysts anticipate that earnings and revenue growth will align, indicating stable profit margins.

On one hand, TSMC’s growth in revenue and production could lead to increased operating leverage and corresponding profit margins, due to lower growth in management expenses.

On the other hand, TSMC’s investment in new capacities—especially for AI chips—might incur additional costs. Analysts seem to believe these factors will offset each other, though history shows they might underestimate TSMC. The company has exceeded EPS expectations for 20 consecutive quarters.

TSMC is likely to report strong operating cash flow, potentially exceeding $10 billion. However, substantial capital expenditures for new capacities—which are crucial for driving business growth—will mean that free cash flow might not reach the levels of operating cash flow.

Positive Q4 Guidance Expected

For Q4, we anticipate management will provide a positive outlook. As a key manufacturer for companies like $NVIDIA Corp(NVDA)$ and $Advanced Micro Devices(AMD)$ , TSMC is reaping the rewards of the ongoing AI growth surge, which should be reflected in this quarter’s performance. Analysts predict Q4 revenue will grow around 25% compared to Q4 2023, a target that seems quite achievable.

Given TSMC’s historically conservative guidance—which explains why they easily surpassed their own Q3 projections—we wouldn’t be surprised by another slightly cautious estimate. This approach often allows for performance that exceeds projections, a more favorable situation than overpromising and underdelivering.

Attractive Valuation

Currently, TSMC’s expected net profit for this year implies a P/E ratio of 28 times. Considering its record of exceeding street EPS expectations, a fiscal year EPS higher than current projections wouldn’t be shocking, suggesting a "real" P/E might be closer to 27. While not exceptionally low, this valuation remains attractive.

As FY2024 wraps up in less than three weeks, we can also look ahead to FY2025. Estimates suggest TSMC will have a P/E ratio of 22 times next year. Given analysts’ tendency to underestimate TSMC, the actual profits could surpass expectations, potentially lowering next year's "real" valuation to below 22.

TSMC's Competitive Edge

A P/E in the low 20s is hardly steep for a company boasting double-digit growth and a strong market position. No other company in the foundry space rivals TSMC, giving it a dominant edge in negotiations with suppliers and customers—those seeking the best chips have little choice but to work with the top foundry.

Of course, no company is without risks, and TSMC is no exception. However, its stellar execution track record suggests low execution risk. With TSMC’s market dominance and Intel’s challenges, competitive threats appear minimal.

As trends like AI, autonomous driving, and cloud computing continue to grow, TSMC’s profits are set to rise, leading to increases in both stock price and dividends in the coming years.