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TSMC: "Alternative" Backbone in the Wave of Order Cuts

$$Taiwan Semiconductor.US released its Q2 2022 earnings report (ending June 2022) before the Longbridge pre-market on the afternoon of July 14th Beijing time, with the following highlights:

1. Revenue: Although both volume and price increased, the growth rate converged. TSMC's Q2 revenue reached $18.16 billion, close to the upper limit of the previous guidance ($17.6-18.2 billion). Quarterly revenue growth was driven by a 0.6% increase in shipments and a 2.8% increase in average selling price. Although both volume and price increased, the growth rate was lower than that of the previous quarter.

2. Gross margin: Price increases converged, and material costs finally decreased. TSMC's Q2 gross margin was 59.1%, exceeding the upper limit of the guidance range (56-58%). The main reasons for the increase in gross margin this quarter were the impact of price increases and cost reductions. Terminal demand was weak, semiconductor downside risks were highlighted, and chip prices continued to be under pressure. The increase in gross margin this quarter, which exceeded market expectations, was mainly due to the decline in material costs (consistent with Dolphin Analyst's expectation in the previous quarter's comment "TSMC: Strong 'Faith', Irrelevant to the Cycle": while maintaining stability on the price side, the reason for the continued increase in gross margin is likely to come from the decline in material costs. It is speculated that the cost of raw materials is expected to decrease in the next quarter).

3. High-performance computing fills the gap left by weak smartphones, and the proportion of advanced processes continues to increase. Since 2022, demand for smartphones has been continuously low, and high inventory levels of terminal manufacturers have reduced demand for chips, resulting in a continued decline in the proportion of smartphone business. Driven by the continuous growth of applications such as cloud computing, high-performance computing has filled part of the capacity gap left by smartphones. The proportion of advanced processes below 7nm continued to increase this quarter, and the company expects 3nm to begin mass production in the second half of the year, when the proportion of advanced processes is expected to continue to increase.

4. TSMC's performance guidance: Expected revenue for Q3 2022 is $19.8-20.6 billion (market expectation is $18.7 billion) and gross margin is 57.5-59.5% (market expectation is 56.1%), both exceeding market expectations. The increase in revenue is a seasonal behavior. As the gross margin has already reached 59.1% in Q2, there is no significant increase expected in Q3, but it is still expected to remain at a high level.

Overall, the market has already expected TSMC's Q2 revenue situation due to the company's monthly disclosure of operating data. Compared with revenue, the market pays more attention to gross margin, and the reason why gross margin once again exceeded market expectations this quarter is mainly due to a decline in material costs.

Compared with Q2 performance, the company's Q3 guidance exceeded market expectations again. According to the guidance, revenue is expected to reach a new high, and gross margin is also expected to remain at a high level. The increase in revenue is due to seasonal factors, and gross margin will also benefit from price increases brought by new processes in the second half of the year, continuing to remain at a high level. The semiconductor industry is cyclical, and with the shrinking demand for smartphones, PCs, and other end products, the inventory of related supply chains is gradually increasing, and the entire semiconductor industry is facing downward risks (as mentioned in Dolphin Analyst's article "Is the Semiconductor Industry Really Going to Change?"). TSMC management also mentioned in this earnings call that there will be a typical chip demand downturn cycle in 2023. Therefore, in the case of a demand downturn, the rise in chip prices is unsustainable.

However, due to the leading nature of its own products, TSMC still has the potential to achieve alpha growth. With the mass production of the 3nm process in the second half of the year, the company's product structure will further migrate to more advanced processes, which is expected to boost the company's prices and gross margins. Even if the industry cycle is downward, and the prices of fully competitive mature process markets are declining, TSMC still has the potential to continue to grow with its leading advanced processes. This is also the confidence behind the company's target annual compound growth rate of 15% to 20%.

Certainly, TSMC will also be affected by the semiconductor cycle downturn, but because more than half of the company's revenue is in the 7nm and below process nodes. Currently, there are only two players in the 7nm and below market, TSMC and Samsung, which is almost a duopoly market. Previously, customers such as Qualcomm had also used Samsung's process, but there were feedback issues such as overheating. Therefore, chip manufacturers will prioritize TSMC when choosing a manufacturing plant. Due to TSMC's leading position in advanced processes, its related prices are not greatly affected by the overall semiconductor cycle. The company is expected to cross the downturn cycle with its technological advantages and achieve sustained growth.

After experiencing the valuation decline of US growth stocks, TSMC is still one of the companies with irreplaceable core capabilities in the US stock market. With the mass production of 3nm in the second half of the year, the gap between TSMC and manufacturers above the 10nm process will further widen.

This article is an original article by Dolphin Analyst. Unauthorized reproduction is prohibited. It is recommended that interested users add the WeChat account "dolphinR123" to join the Dolphin Analyst circle and discuss global asset investment views together!

Regarding specific financial performance, Dolphin Analyst focuses on the following aspects:

  1. How much did TSMC's record-breaking revenue, wafer shipments, and prices contribute in each dimension?
  2. With the high gross margin guidance given this quarter, can TSMC achieve its gross margin target?
  3. How did TSMC's downstream applications perform this quarter? How is the proportion of advanced processes in this quarter with the expected launch of 3nm mass production within the year?

Dolphin Analyst will seek answers to these questions in the financial report. I. Revenue: Although both volume and price have risen, the growth rate has converged

TSMC achieved revenue of USD 18.16 billion in Q2 2022, close to the upper limit of the previous performance guidance (USD 17.6-18.2 billion), setting a new quarterly revenue record for the company. Revenue in this quarter increased by 3.4% QoQ, and the growth rates of downstream applications in this quarter have slowed down, especially in the smartphone business, which has seen a QoQ decline due to declining demand.

TSMC's quarterly revenue has been fully expected due to the disclosure of monthly operating indicators. One thing to note in this quarter is that although the quarterly revenue has set a new historical high, the monthly revenue in June showed a QoQ decline, and it is the first time in nearly three years that a QoQ decline in revenue has appeared in June. This is mainly because the new process technology has not yet started mass production, and the overall downside risk of the semiconductor industry is highlighted. The mass production of new processes in the second half of the year will bring new growth momentum.

Did TSMC's revenue growth in Q2 mainly come from price increases or shipment volume increases?

Dolphin Analyst observes the main driving force behind TSMC's Q2 revenue growth from the dimensions of volume and price:

1) Volume dimension: TSMC's wafer shipments in Q2 were 3,799 thousand pieces, a QoQ increase of 0.6%. Looking at each quarter, TSMC's wafer shipments are still increasing, but the growth rate has narrowed. Combined with the capital expenditure situation, TSMC's capital expenditure in this quarter was USD 7.34 billion, a decrease from the previous quarter. Due to equipment and inflation pressures, the company will postpone some of its capital expenditures in 2022 to 2023.

2) Price dimension: TSMC's wafer revenue per wafer (equivalent to 12-inch wafers) in Q2 was USD 4,780 per piece, a QoQ increase of 2.8%. In this quarter, TSMC's wafer shipment price continued to rise, but the rate of increase has significantly slowed down. The shrinking demand from some downstream customers has put pressure on the continued price increase, and the increase in the proportion of 5nm revenue in this quarter has a structural impact on the price increase.

Dolphin Analyst believes that TSMC's revenue in this quarter still benefited from the drive of both volume and price increases. However, due to the shrinking demand from some downstream customers, the growth rates of both volume and price have converged in this quarter, especially the rare QoQ decline in monthly revenue in June. As the growth impact brought by the semiconductor industry's price hike gradually recedes, the market will test whether TSMC has the ability to surpass the cycle. Dolphin Analyst believes that as TSMC continues to move towards higher process structures, the company's revenue is still expected to benefit from structural changes and achieve continued growth.

Second Quarter Gross Profit and Gross Margin: Price Increase Convergence, Material Costs Finally Decrease

Taiwan Semiconductor achieved a gross profit of 10.73 billion US dollars in the second quarter of 2022, a 9.7% increase from the previous quarter. The main reason for the higher quarter-on-quarter growth rate than the revenue growth rate (3.4%) was the unexpected increase in gross margin. The gross margin of Taiwan Semiconductor in the second quarter was 59.1%, exceeding the upper limit of the guidance range (56-58%).

In the second quarter, Taiwan Semiconductor's gross profit increased by 9.7% quarter-on-quarter, with revenue contributing +3.4% and gross margin contributing +6.1%.

The two most important data points for Taiwan Semiconductor in the market are revenue and gross margin. Due to the monthly release of operating data, quarterly revenue has basically been anticipated by the market. Gross margin is one of the focus points of this quarter's report. Dolphin Analyst will analyze the main drivers of the gross margin increase this quarter:

"Gross Profit = Wafer Revenue - Fixed Costs - Variable Costs"

  1. Wafer Revenue (equivalent to 12 inches): In the second quarter, Taiwan Semiconductor's wafer revenue was about 4,780 US dollars/piece, an increase of 130 US dollars/piece quarter-on-quarter. The main reason for the increase was the overall price increase of wafer products, but the increase this quarter was smaller than the previous quarter (+425 US dollars/piece).

  2. Fixed Costs (Depreciation and Amortization): In the second quarter, Taiwan Semiconductor's average fixed cost was about 1,013 US dollars/piece, a decrease of 39 US dollars/piece quarter-on-quarter. The total depreciation this quarter has slightly increased, but with the release of production capacity, the fixed cost per wafer has decreased.

  3. Variable Costs (Other Manufacturing Costs): In the second quarter, Taiwan Semiconductor's average variable cost was about 944 US dollars/piece, a decrease of 68 US dollars/piece quarter-on-quarter. The total amount of other manufacturing costs this quarter has decreased for the first time in seven quarters. At the same time, as the company's shipments continue to grow this quarter, it can be seen that the pressure of rising raw material prices has eased this quarter, which also helps the company's gross margin performance exceed expectations.

From this quarter's financial report, the pressure of rising raw material prices on the company's cost side has eased, and the company has benefited from the decrease in variable costs in terms of gross margin.

Combining the above breakdown, Taiwan Semiconductor's gross profit per wafer this quarter was 2,823 US dollars/piece, an increase of 236 US dollars quarter-on-quarter. The gross margin this quarter (59.1%) achieved a +3.4% increase, mainly due to the price increase and the reduction of cost pressure.

Dolphin Analyst believes that the unexpected increase in Taiwan Semiconductor's gross margin this quarter comes from both price increases and cost reductions. Through the breakdown of Taiwan Semiconductor's wafer cost this quarter, it can be seen that the cost pressure on the material side has eased. Although the company's product price increase has slowed down, the decrease in material costs has provided some support for the company's profitability.

3. Wafer Structure End: High-performance computing fills the gap left by weak smartphones, and the proportion of advanced processes continues to increase.

3.1 Wafer Revenue Proportion (by Application Type)

Smartphones and high-performance computing are still the largest sources of revenue for TSMC, accounting for more than 80% of the total.

Looking at each sub-application, the major structural change is the continued decline in the proportion of smartphones, while high-performance computing has increased somewhat. The main reason is that the demand for smartphones has been continuously low since 2022 (refer to Dolphin Analyst's "Consumer Electronics 'Mature', Apple Stands Firm, Xiaomi Struggles"). The high inventory of terminal manufacturers has reduced the demand for chips. Although the demand for graphics cards in high-performance computing has declined, the cloud computing market and other markets are still growing, which can digest the production capacity of some processes of smartphones.

From the unsatisfactory sales during the 618 shopping festival this year, Dolphin Analyst believes that the inventory of smartphones has not been fully digested. In the second half of the year, the inventory of Android phones will continue to be digested, and with the release of new Apple phones, the proportion of smartphones is expected to increase.

3.2 Wafer Revenue Proportion (by Process Node)

TSMC's advanced processes continue to increase, with 5nm node revenue accounting for 21% this quarter, while 7nm node revenue continues to stabilize at 30%, and revenue from advanced processes below 7nm has exceeded 50%.

This quarter is the third consecutive quarter that the 5nm process accounts for more than 20%, which shows that TSMC's 5nm has been introduced by multiple customers after Apple, and the 5nm process has reached a stable mass production state similar to the previous 7nm. With the promotion of intelligent applications such as automotive, more and more cockpit chips, autonomous driving chips and other products are expected to transition from 7nm to 5nm process nodes.

For the layout of 3nm, the company expects to start mass production in the second half of 2022 (consistent with Dolphin Analyst's previous expectations, TSMC generally introduces a new generation of process technology every 2-3 years). The company also plans to produce 2nm chips in 2025. Dolphin Analyst believes that with the mass production of 3nm, it is expected to further drive the increase in the company's wafer prices and revenue, and further shift the revenue structure towards advanced processes. At that time, the proportion of revenue from processes below 7nm is expected to continue to increase.

Taiwan Semiconductor Manufacturing Company (TSMC)

Proportion of wafer revenue by region

From the perspective of revenue from various regions, North America is still the largest source of revenue for TSMC, accounting for more than 60%. Its major customers include Apple, Qualcomm, Nvidia, AMD, etc., among which Apple accounts for more than 20% of the company's revenue. Outside of North America, China and the Asia-Pacific region are the other two major sources of revenue, both accounting for more than 10%.

Since the low point at the end of 2020, the proportion of revenue from China has been in double digits for five consecutive quarters. From the current proportion, Chinese customers have filled some of the demand of the company's previous major customers in China, but there is still a gap from the previous 20% proportion. With the development of the domestic semiconductor industry, Dolphin Analyst believes that the proportion of revenue from China is expected to continue to steadily rise.

Dolphin Analyst's research on TSMC and the wafer manufacturing industry.

TSMC

April 14, 2022 TSMC conference call "2nm on schedule (TSMC conference call)"

April 14, 2022 TSMC financial report review "TSMC: Strong "Faith", Irrelevant to Cycle"

April 8, 2022 TSMC stock in-depth analysis "TSMC (Part 2): Price Discounted, Faith Unwavering"

March 16, 2022 TSMC stock in-depth analysis "After the market crash, let's talk about the ash-grade foundry king TSMC again"

January 13, 2022 TSMC conference call "After giving strong quarterly guidance, what did TSMC management talk about?"

January 13, 2022 TSMC financial report review "TSMC is too good at it, "cycle" takes a detour"

October 14, 2021 TSMC financial report review "TSMC: The leader takes the lead, still in the limelight"

Semiconductor/Wafer Manufacturing Industry

June 24, 2022 Semiconductor Industry Overview "Cutting orders, is the semiconductor industry really going to "change"?"

September 3, 2021 Wafer Manufacturing Industry Overview "Performance up, stock price down: Should SMIC be "killed" or "mistakenly killed"?"

July 16, 2021 SMIC Stock In-Depth "SMIC (Part 2): The Undervalued Chinese "Core""

July 9, 2021 SMIC Stock In-Depth "SMIC (Part 1): On the "Core" Strategy of the Leading Chipmaker"

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