Semiconductor Downturn, How Can TSMC Continue to Grow? (TSMC Conference Call)

$$Taiwan Semiconductor.US released its Q2 2022 earnings report (ending June 2022) before the Dolphin Analyst's US stock market opening on the afternoon of July 14th, Beijing time. The highlights are as follows:

Quarterly core data vs. market expectations:

1. Revenue: Achieved $18.16 billion this quarter, up 3.4% QoQ, meeting guidance expectations ($17.6-18.2 billion);

2. Gross margin: The quarterly gross margin reached 59.1%, up 3.4pct QoQ, exceeding guidance expectations (56-58%);

3. Business situation: The proportion of mobile phones continued to decline, and revenue from processes below 7nm exceeded half and continued to increase;

4. Next quarter guidance: Q3 2022 revenue of $19.8-20.6 billion (market expectation of $18.7 billion) and gross margin of 57.5-59.5% (market expectation of 56.1%).

For detailed financial information, please refer to Dolphin Analyst's review "TSMC: The "Alternative" Backbone in the Wave of Order Cuts".

I. Telephone conference incremental information summary:

1) Annual guidance: Annual revenue guidance is around 30% (continuing to maintain); annual capital expenditure is $40-44 billion (continuing to maintain), but this quarter mentioned a downward trend close to $40 billion (actually lowered);

2) Long-term gross margin: 53% or higher (continuing to maintain). Since the Q2 gross margin has reached 59%, the gross margin may also decline in the medium and long term as the semiconductor cycle declines;

3) Company business outlook: ① Growth in 2023 comes from advanced processes (driven by new processes); ② The inventory of the sluggish market will continue to decline in the second half of the year (indicating that the current inventory is still relatively high); ③ The long-term revenue in the next few years will be between 15%-20% compound annual growth rate;

4) 3nm/new process progress: ①3nm: Mass production in the second half of 2022, with revenue contribution in the first half of 2023, will dilute the overall gross margin by 2-3 points; ②2nm: Expected to start trial production in 2024 and mass production in 2025. Compared with N3E, the speed is increased by 10-15% under the same power, and the power is optimized by 20-30% under the same speed, with an increase of more than 20% in logic density;

5) Semiconductor industry cycle: There will be a typical chip demand downturn cycle in 2023, but the overall decline will be better than in 2008. Currently, the company does not discuss the previous $100 billion capital expenditure guidance.

II. Telephone conference transcript:

Company guidance:

1. Revenue: 2022 revenue (in USD) will increase by around 30%
2. Q3 revenue guidance is $19.8-20.6 billion, with a median increase of 11.2% QoQ (based on USD: NTD = 1:29.7 assumption)
3. Gross margin guidance: 57.5% to 59.5%
4. Operating profit margin guidance: 47% to 49%
5. Long-term gross margin guidance remains unchanged at 53% or higher.
6. Capital expenditure: Capital expenditure for 2022 will remain at the January 2022 earnings call guidance of $40-44 billion, but due to equipment issues, capital expenditure for 2022 will be pushed to 2023, with the expectation that capital expenditure for 2022 will be closer to the lower end of the forecast range. The previous guidance of $100 billion will no longer be discussed and will be adjusted in real-time.
7. Tax rate: 2022 tax rate guidance of 10% to 11%, with an effective tax rate increase in 2023.

Company outlook:

1. Growth: Advanced processes will drive growth in 2023.
2. Inventory: Due to weak momentum in the smartphone, PC, and consumer terminal markets, we have observed that the supply chain has taken action, and we expect inventory levels to decline in the second half of 2022. We expect excess semiconductor supply chain inventory to take several quarters to rebalance to a healthier level. We believe that inventory adjustments may continue for several quarters until the first half of 2023.
3. Capacity: We expect tight capacity throughout 2022, with capacity utilization remaining strong in 2023.
4. Long-term demand: In the coming years, silicon content growth will be higher, in the mid to high single-digit percentage range, and will support the long-term structural demand for semiconductors, including HPC, automotive, mobile phones, IoT, and other fields.
5. Long-term revenue: Long-term revenue in the coming years will be between 15% and 20% compound annual growth rate.
6. N3: Mass production in the second half of 2022, with revenue contribution in the first half of 2023, will dilute overall gross margin by 2-3 points. It is expected to climb smoothly thereafter, driven by HPC and mobile phones.
7. N2: In progress, trial production is expected in 2024, and mass production in 2025. We are working with customers, who are more concerned about effective power, and the proportion of chiplet customers is increasing. It has a 10-15% speed increase at the same power consumption and a 20-30% power optimization at the same speed, with a 20%+ logic density increase compared to N3E.

Analyst Q&A

Q: What is the reason for the inventory outlook for the second half of this year and inventory adjustment in the first half of next year?

A: We did have about 35% growth this year. But we also hope that our customers will start taking action to reduce inventory levels. We expect them to continue inventory adjustments at least until the first half of 2023. Despite ongoing inventory adjustments and macro uncertainty, the structural growth trajectory of long-term semiconductor demand remains strong. We expect our capacity to remain tight, and our business to be more resilient. We are confident in both short-term and long-term growth prospects.

Q: Will the increase in capital expenditure have a greater impact on the cost of 3nm, 5nm, or mature nodes? Will it affect capital expenditure in 2023? A: There are some changes in both advanced and mature nodes; it is too early to talk about next year's capital expenditures, and this year's CAPEX is closer to the lower end of the 40-44b$ range.

Q: What is the breakdown of the driving force behind the compound annual growth rate of 15% to 20% in the next few years, in terms of shipment volume, ASP, or silicon content improvement?

A: I cannot tell you the specific numbers because they are confidential. The growth of silicon content in advanced equipment is actually at least in the high single digits. Although the overall growth of electronic devices is very slow or low single digits, it is still growing. Combining all of these with our value sales to customers, we are confident that a compound annual growth rate of 15% to 20% can be achieved.

Q: TSMC will expand its mature node professional capacity by 50%. Is this all new capacity? What is driving the demand growth?

A: The 50% growth refers to the special process capacity. This does not mean that the overall capacity will increase. We are doing this because of our customers' demand, and we are working closely with them to support growth.

Q: Most of the past expansions have focused on advanced nodes. What gives TSMC the confidence to expand in professional technology?

A: We can see that the silicon content continues to increase in various terminals. Therefore, under the requirements of customers, TSMC works closely with them to expand our professional technical capabilities. We are very confident about this.

Q: What is the basic situation of TSMC in 2023? Do you think this will be a typical cycle, such as the downturn in 2015 or 2019?

A: Yes, our basic situation is a typical downturn cycle. Inventory correction may last for several quarters, similar to 2008, but this is not a major downturn cycle.

Q: What is the revenue contribution of N3 in 2023? In addition, as N3's capacity increases, what impact will it have on profitability?

A: As far as the revenue contribution of N3 is concerned, it is meaningless to talk about the revenue contribution of the leading node at the beginning compared to the past because the total amount is increasing, and we believe it will continue to increase. In terms of amount, it is definitely larger than the first few nodes in the initial stage. In terms of diluting profitability, we expect it to affect gross margin by 2 to 3 percentage points in 2023.

Q: How do you view the trend of fabless DOI in the second half of this year?

A: We expect fabless DOI to gradually decline in the second half of the year.

Q: Changes in the industry's growth expectations for 2022 and 2023?

A: Our semiconductor forecast does not include memory, and the growth forecast for 2022 is the same as our previous forecast. For 2023, it is too early to make a prediction.

Q: Other companies in the industry are using project financing to establish new wafer fabs, such as the leasing model for new wafer fabs. What is TSMC's view on this?

A: We are not considering project financing at the moment. Usually, project financing requires strict terms and higher costs. We will mainly provide funds for expansion through our operating cash flow and borrowing using our strong balance sheet.

Q: HPC inventory?

A: You may expect customers to have too much inventory in HPC. However, we believe that cloud computing is growing steadily, and we think our business has less volatility.

Q: Will there be a significant inventory adjustment in the high-end smartphone market?

A: We have not seen excessive inventory in high-end smartphones, so there is no adjustment.

Q: N2 logic density gain exceeds 20%. But does this represent a significant slowdown, especially in the context of Moore's Law? What does this mean for the entire technology?

A: N2 will be the most advanced because we are working with customers. N2, including transistors, packaging, not just more chips on the wafer. Customers are more concerned about effective power.

Q: How do we view HPC in the next few years? Is it driven by ARM or x86?

A: TSMC is everyone's foundry, and we hope there will be growth for both. Arm and x86 both have increased revenue contributions. HPC will be the biggest contributor and will increasingly become the main driver of TSMC's growth in the next few years.

Q: What cost differences does TSMC see in US expansion? What discussions and negotiations have been conducted with customers and governments regarding higher costs and subsidies?

A: The cost is higher in the US, and labor costs have been higher in the past few years. We have communicated with the government and have sufficient expectations for costs. Customers need local factories, and we are also working hard to reduce costs. We have joint investments with the government 20 years ago. Our customers' needs are fluctuating, and we do not want to be limited to a certain type of customer, so there is currently no plan for joint investment.

Q: Will N3 dilute gross margin next year, and what is the dilution relative to?

A: It is for next year's gross margin, and the 53% long-term gross margin has already taken into account the dilution.

Q: Do we expect mobile customers to accept 3D IC, SOIC at some point in the future?

A: SOIC is now widely accepted by HPC customers. But for mobile, we also have other solutions to meet the requirements.

Q: As early as April 2021, TSMC provided guidance for $100 billion in capital expenditures over the next three years. Now adding up last year and this year's numbers, does this mean that capital expenditures in 2023 will decrease? Or is there a new revised capital expenditure guidance?

A: We are not discussing the previous 100 billion guidance. Annual revision of capital expenditures is mainly due to future opportunities, as long as there are opportunities in the future, there is a cautious plan.

Q: Despite the increase in capital expenditures, why has depreciation growth been relatively flat or low so far this year? Should we expect an increase in depreciation in 2023?

Q: If customers further aggressively reduce inventory, what is TSMC's strategy?

A: Customers are adjusting inventory, but this year's overall supply and demand is tight, and our capacity remains tight, with sustained healthy utilization.

Q: Which field is most receptive to advanced packaging? Revenue growth guidance?

A: We are developing advanced packaging to meet customer needs, starting with HPC customers, and will be widely accepted in the future. We believe that there will be more 3D IC demand in N2.

Q: Will the carrier board be used more in 3D and 2.5D ICs?

A: Both 3D and 2.5D ICs are important, and we will meet customer needs in the direction of higher computing performance and larger carrier boards.

Q: What drives TSMC's Capex, EUV or other equipment?

A: Annual capital expenditures may vary by quarter. No details can be provided.

Q: What drives TSMC's pricing strategy, cost inflation or other factors?

A: We do not comment on details. Pricing is strategic, based on value, not opportunism or cost markup. We do face manufacturing cost challenges. As we mentioned, rising raw material, utility, and tool costs, etc. Nevertheless, we still believe that a long-term gross margin of 53% is achievable, and even higher than 53%.

Q: What percentage of chip architecture methods are used for HPC applications on N2?

A: We cannot disclose this number. The only information we can provide is that the number of customers using chips in N2 or 2nm technology will begin to increase, which will become the main way for 2nm and below technologies.

Dolphin Analyst's research on TSMC and the semiconductor manufacturing industry

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