TSMC 24Q2 Preview: Earnings growth is expected to continue this quarter, can the stock price reach a new high?

In 2024, the demand for integrated circuit chips in industries such as AI and new energy vehicles has surged, pushing TSMC’s stock price higher. Since the beginning of the year, the company's stock has risen by 81.7%, significantly outpacing the S&P 500's 18.4% gain. TSMC is expected to release its Q2 2024 earnings report on July 18 (Eastern Time), potentially sparking a new wave of trading opportunities.

Revenue Structure: As a semiconductor foundry, TSMC's core business in chip processing includes wafer foundry and assembly and testing, supporting the entire process from design to production.

About 87.1% of TSMC's revenue comes from wafer production and sales, encompassing chips of various sizes and specifications, along with assembly and testing; the remaining 12.9% of revenue comes from other business activities combined. By application, the high-performance computing (HPC) sector contributes the largest share of revenue at 43.2%, followed by other major sectors such as smartphones, IoT, automotive, and consumer electronics.

Key Outlook: As a foundry, TSMC benefits from the high demand for chips and computing power, with major tech giants investing heavily in AI. TSMC has secured a stable customer base, including NVIDIA, AMD, and Intel, which ensures steady sales and order growth. So, the main factors influencing TSMC’s performance and fundamental growth include changes in supply and demand, orders, and production capacity, as well as the company's profit margins.

This year, TSMC's primary order demand is focused on its 3nm process technology. Strong demand from Apple, Intel, and AMD has driven significant revenue growth for this technology, establishing 3nm as a new revenue pillar. These three major clients plan to adopt TSMC's 3nm technology extensively in 2024 for their latest generation of processors and chipsets.

Additionally, NVIDIA's upcoming next-generation gaming graphics cards and the Blackwell architecture GPUs, expected to ship in the second half of the year, will use TSMC’s 4nm chips. According to TrendForce, NVIDIA has increased orders for related chips by 25%.

Those new orders highlighting the urgent market demand for cutting-edge semiconductor manufacturing capabilities and reinforcing TSMC’s crucial role in the global chip supply chain.

TSMC currently has approximately 80% to 90% of its production capacity located in Taiwan. If Taiwan's wafer fabs were to lose production capability, TSMC could face a risk of capacity depletion, and relocating fabs outside Taiwan is nearly impossible. On the demand side, the recent surge in chip demand driven by artificial intelligence and high-performance computing has led tech giants to increase their orders to TSMC and other foundries. This necessitates TSMC to enhance its factory capacity to meet the increasing wafer foundry demand from technology companies. In September 2023, TSMC Chairman stated, "Our capacity cannot meet 100% of customer demand, but we will strive to meet 80% of it."

To address the continuously growing demand for wafer foundry services and mitigate the risks of concentrated production in a single region, TSMC is currently investing in new wafer fabs globally. For example, TSMC's factory construction in Arizona, USA, has reached its third phase, and the wafer fab in Kumamoto Prefecture, Japan, has announced a second phase of construction. TSMC also plans to build new factories in Germany and other countries. Additionally, TSMC continues to invest in factory construction and further development in Taiwan. These construction and investment plans require significant capital expenditures: from 2018 to 2023, TSMC's capital expenditure increased from $10.4 billion to $30.4 billion, nearly tripling. Even with government subsidies and policy incentives from various countries, the construction of these not-yet-operational factories involves substantial costs. The good news is that the strong demand in the AI sector compensates for this expenditure. Overall, TSMC's net profit has increased from $11.1 billion to $26.9 billion over the past five years, not being hampered by the rising expenditures.

At the European Technology Workshop in May 2024, TSMC announced plans to expand CoWoS (Chip on Wafer on Substrate) capacity with a compound annual growth rate (CAGR) of over 60%, at least until 2026. If capacity upgrades proceed smoothly, CoWoS capacity in 2026 is expected to be more than four times the 2023 level. Additionally, TSMC plans to expand SoIC capacity with a 100% CAGR by the end of 2026, with SoIC capacity expected to be eight times the 2023 level by the end of 2026. Other technologies and products are also projected to have substantial capacity growth. Therefore, TSMC's capacity is expected to see large-scale growth in the coming years, further enhancing its fundamentals and business capabilities.

In the short term, TSMC faces significant challenges in maintaining its profit margins due to high capital expenditures. From August 2023 to March 2024, some wafer foundries have reduced prices for mature chip process technologies by approximately 5%. Therefore, raising prices for mainstream products during a price war may lead customers to seek other foundries.

Additionally, high R&D expenses also impact profit margins: TSMC invests heavily in R&D to maintain its technological edge, with expenditures rising from $2.96 billion in 2018 to $5.85 billion in 2023. According to consensus expectations, R&D and technology expenditures for Q2 2024 are estimated at $1.538 billion, up 13.44% year-over-year. Under these multiple pressures, TSMC's gross profit margin and net profit margin for 2024 are not optimistic: consensus expectations indicate that TSMC's Q2 2024 gross profit margin is 52.55%, down 2.89% year-over-year; net profit margin is 35.67%, down 5.64% year-over-year.

Even with a short-term decline in profit margins, TSMC's long-term sales profit trend remains positive: on June 5, NVIDIA's CEO Jensen Huang emphasized that TSMC's foundry prices are low and supported the company's planned price increases. According to investors citing a Morgan Stanley client report, TSMC plans to raise wafer prices by up to 10% in 2025, significantly alleviating TSMC’s profit margin issues in 2025 and beyond. Therefore, although TSMC faces a slight decline in net profit margin in the short term, there is considerable upward potential for net profit margin in 2025 and beyond.

Despite recent issues with insufficient capacity and rising capital expenditures, expectations for TSMC's Q2 2024 revenue and profit remain optimistic. The technology industry's surging demand for chips, driven by increasing semiconductor content in hardware products, the rise of artificial intelligence, and the further proliferation of IoT, has undoubtedly had a major impact on the company’s revenue potential. This trend shows no signs of cooling down: based on currently published monthly sales figures, TSMC's sales in the second quarter have already achieved a year-over-year growth of 40.1%. Even though capacity expansion plans are still underway and the planned price increases have not yet been implemented, the current market's huge demand for AI chips and CoWoS, combined with TSMC’s outstanding operational capabilities, makes the growth in Q2 2024 sales and profits promising. According to Bloomberg consensus expectations, TSMC's Q2 2024 revenue is projected to be $20.06 billion, up 28.17% year-over-year; net profit is expected to be $7.152 billion, up 20.87% year-over-year; and adjusted basic EPS is anticipated to be $0.28, up 21.41% year-over-year.

The issues currently faced by TSMC are expected to be resolved within a few years: in terms of capacity, the company is not standing still but is actively increasing capacity to meet the huge demand for chips from customers; in terms of profit margins, the company's planned price increases are expected to fill the temporary gaps in gross and net profit margins in the near future. These forthcoming commitments instill confidence in the market; meanwhile, TSMC’s performance is also showing strong growth. As long as the demand for high-performance chips in the technology sector continues, TSMC’s performance growth remains promising.

In terms of shareholder returns, TSMC’s dividend yield (TTM) is 1.03%, which is not particularly high. On June 28, 2024, TSMC completed its stock repurchase plan for June to August this year, with the repurchased shares accounting for 0.01% of the current total outstanding shares. Throughout 2023, the company's total outstanding shares slightly increased, meaning that the number of shares issued by TSMC in 2023 exceeded the number repurchased by the company.

This indicates that investors cannot rely on dividends or stock repurchases for returns. Meanwhile, Bloomberg estimates the company’s forward P/E ratio at 28.83x, indicating a relatively reasonable valuation level.

For investors holding the stock: If considering profit-taking, they can choose to sell a certain number of call options with a higher strike price or sell some put options to earn premiums, ensuring enough cash reserves in case of potential exercise.

For investors not holding the stock: It is advisable to buy call options or some shares of the stock to gain from potential price increases; alternatively, they can choose to sell put options with a lower strike price.