TSMC: NVIDIA comes to the rescue, AI supports the "cyclical" bottom

TSMC announced its Q2 2023 earnings report (ending in June 2023) before the US stock market opened on the afternoon of July 20, 2023. The key points are as follows:

1. Revenue: Bottoming out, recovery is imminent. In Q2 2023, TSMC's revenue reached $15.7 billion, which is at the lower end of the performance guidance range ($15.2-16 billion). Quarterly revenue declined compared to the previous quarter, with a -9.6% impact from shipment volume and a +3.8% impact from average selling price. Prices have rebounded, mainly due to the increased shipment of higher-priced wafers using advanced processes such as 7nm, while the decline in shipment volume is mainly due to the overall industry downturn.

2. Gross profit and gross margin: 3nm will suppress gross margin. TSMC's gross margin in Q2 2023 was 54.1%, reaching the upper end of the guidance range (52%-54%), but it declined by nearly 2.2 percentage points compared to the previous quarter. Previously, TSMC's gross margin frequently rose and exceeded 60% during the semiconductor boom cycle, but this is not sustainable. Although the average selling price has rebounded this quarter, there has also been a significant increase in costs, ultimately affecting the company's gross margin.

3. Core business: High-Performance Computing (HPC). With increasing demand, the proportion of HPC and automotive continues to rise. HPC's share has increased to 44% and has become a new core of the company's business. In terms of process nodes, although 3nm has not yet achieved mass production, the combined share of 5nm and 7nm remains stable at over 50%.

4. TSMC's performance guidance:

Dolphin's overall view:

TSMC's earnings report for this quarter is slightly better than market expectations. Considering the monthly data disclosed, the market has already anticipated the decline in TSMC's revenue compared to the previous quarter. The focus of the report is on the company's gross margin and the progress of various businesses. Although the product average selling price has rebounded, costs have also increased, resulting in a decline in gross margin for this quarter, but it is better than market expectations.

According to TSMC's guidance for the next quarter: Revenue is expected to reach $15.2-16 billion (a QoQ increase of 6.5%-11.6%), and the gross margin is expected to be 51.5%-53.5% (a QoQ decrease of 0.6-2.6 percentage points). From the revenue guidance, TSMC will benefit from Apple's new product inventory in the next quarter. From the gross margin guidance, the company's profitability will still be under pressure in the next quarter, and the mass production of 3nm will also exert pressure on the gross margin to a certain extent.Due to the company's management expecting a 10% decline in annual revenue, Dolphin speculates that TSMC's Q3 and Q4 quarterly revenue will be around $17 billion and $19 billion, respectively.

With the impact of AI demand and Apple's new device stocking, the utilization rate of the company's 5nm and 7nm production capacity is expected to approach saturation, and the mass production of 3nm is also getting closer.

Although the company's performance is currently at its lowest point, the company's stock price has already risen by over 50% from the bottom, which already includes some expectations of recovery. Starting from the second half of this year, TSMC's performance is expected to gradually improve. If the AI semiconductor industry experiences a pullback after a short-term rise, it is expected to bring opportunities for market expansion.

Below is Dolphin's specific analysis of TSMC:

1. Revenue: Bottoming out, poised for recovery

TSMC achieved revenue of $15.68 billion in the second quarter of 2023, within the guidance range (between $15.2 billion and $16 billion), with a narrower QoQ decline in revenue. The revenue for this quarter decreased by 6.2% compared to the previous quarter, mainly due to the continued decline in wafer shipments in the semiconductor industry downturn.

TSMC's quarterly revenue has been well anticipated by the market due to the monthly operating indicators released. However, the revenue of TSMC continued to decline this quarter. How did the prices and shipments perform?

Dolphin observes the main drivers of TSMC's revenue growth in the second quarter of 2023 from the perspectives of volume and price:

1) Volume perspective: In Q2 2023, TSMC's wafer shipments were 2,916 thousand pieces, a QoQ decline of 9.6%, continuing to decline. Although there was some boost in demand from AI and other areas, the weak downstream sectors still affected customer pull-in demand. Considering the capital expenditure, TSMC's capital expenditure for this quarter was $8.17 billion, which continued to decrease in the overall weak demand situation. The company's capital expenditure plan for 2023 was relatively conservative (between $32 billion and $36 billion), and the pace of capital investment is still being maintained.

2) Price perspective: In Q2 2023, TSMC's wafer average selling price (ASP) (equivalent to 12-inch wafers) was $5,377 per piece, a QoQ increase of 3.8%. TSMC's wafer ASP stopped falling and rebounded. Although the current semiconductor industry is still at the bottom of the cycle, the growth in AI demand has increased orders for advanced processes such as 7nm, thereby structurally improving the average selling price of the company's products.

As mentioned in Dolphin's analysis report on the earnings report of the previous quarter titled "TSMC: The Strongest King, Yet Difficult to Escape the Cycle," it is stated that "."

Based on TSMC's guidance for the next quarter, 2023Q3 is expected to achieve revenue of 16.7-17.5 billion US dollars (MoM increase of 6.5%-11.6%) and a gross margin of 51.5-53.5% (MoM decrease of 0.6-2.6 percentage points). With the boost from Apple's new device inventory, TSMC's performance is expected to rebound in the third quarter.

Considering the improvement in revenue and shipments, and the continued weakness in gross margin, it is speculated that TSMC's 3nm process is also expected to enter mass production in the near future.

II. Gross Profit and Gross Margin: 3nm Process Suppressing Gross Margin

TSMC achieved a gross profit of 8.49 billion US dollars in the second quarter of 2023, a decrease of 9.9% compared to the previous quarter. The decline in gross profit is mainly due to the decrease in gross margin.

TSMC's gross margin in 2023Q2 was 54.1%, a decrease of 2.2 percentage points compared to the previous quarter. Although the gross margin was better than the market's expectation of 53.3%, it showed a significant decline compared to the previous situation of over 60%.

The 9.9% decrease in TSMC's gross profit in 2023Q2 was influenced by a 6.2% decrease in revenue and a 3.9% decrease in gross margin.

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

Wafer Revenue (equivalent to 12-inch wafers): In 2023Q2, TSMC's wafer revenue was approximately $5,377 per wafer, an increase of $196 per wafer compared to the previous quarter. This was mainly due to the increase in shipments of advanced processes such as 7nm, which led to a structural improvement in average selling price.
Fixed Costs (depreciation and amortization): In 2023Q2, TSMC's average fixed costs were approximately $1,386 per wafer, an increase of $262 per wafer compared to the previous quarter. This was due to the increase in total depreciation and amortization expenses, coupled with a continued decline in shipments this quarter, resulting in a significant increase in the unit cost of depreciation and amortization per wafer.
Variable Costs (other manufacturing expenses): In 2023Q2, TSMC's average variable costs were approximately $1,081 per wafer, a decrease of $58 per wafer compared to the previous quarter. The increase in variable costs per wafer was mainly due to the decrease in manufacturing costs.

Taking all the above factors into account, TSMC's gross profit per wafer in 2023Q2 was $2,910, a decrease of $9 compared to the previous quarter. Although there was a slight decline in gross profit per wafer, the unit price increased by $196, while the unit cost increased by $205.

The decline in revenue of TSMC was already expected by the market, and the gross margin was the main focus this time. Although the increase in average selling price has a positive impact on the gross margin, the increase in costs also suppresses the gross margin. Considering the company's guidance for the next quarter at 51.5-53.5%, TSMC's gross margin may continue to remain low in the next quarter. The Dolphin believes that if 3nm production starts, it will bring more depreciation and amortization, putting certain pressure on the company's gross margin.

III. Wafer Structure: Core, High-Performance Computing (HPC)

3.1 Wafer Revenue Composition (by application type)

Smartphones and HPC are TSMC's largest sources of revenue, accounting for a combined 77%, which is the largest source of downstream revenue for the company.

Looking at the downstream segmented applications, the share of the smartphone business continues to decline to 33%, while the share of HPC and automotive shows an upward trend.

The smartphone market has entered a mature stage with little room for significant growth. On the contrary, HPC and automotive show greater growth potential. HPC mainly includes demand for graphics cards and data centers, while automotive mainly includes new demands in intelligent driving. The Dolphin believes that in the next quarter, with the stocking of new iPhones by Apple, the proportion of smartphones is expected to temporarily increase. However, from a medium to long-term perspective, the impact of the smartphone business on TSMC will continue to weaken, while the impact of HPC and automotive will continue to increase.

3.2 Wafer Revenue Composition (by process node)

In this quarter, the revenue share of 5nm and 7nm still accounts for more than half, and TSMC's revenue from advanced processes remains the largest source of revenue for the company. Specifically, the revenue share of 5nm and 7nm has rebounded this quarter, mainly due to the increased demand for AI and other applications that require the 7nm process.

As for new process nodes, although the company has announced that 3nm can be mass-produced, it has not achieved large-scale production this quarter without major customers adopting it.

The Dolphin believes that based on the guidance given by the company for the next quarter, the company's performance in 2023Q3 will benefit from the stocking of new iPhones by Apple. After achieving a sustained high share with 5nm, the company's 3nm is also expected to be mass-produced in the second half of the year, further increasing the average selling price of the company's products.

3.3 Wafer Revenue Composition (by region)From the perspective of revenue from various regions, North America remains the largest source of revenue for TSMC. $Agilent Tech(A.US)pple.US, $Qualcomm.US, $NVIDIA.US, and $Agilent Tech(A.US)MD.US are some of the major customers contributing to this. In this earnings report, the proportion of revenue from North America has rebounded, mainly due to the addition of new orders from some major US customers.

Apart from North America, China and the Asia-Pacific region are the other two major sources of revenue, accounting for 12% and 8% respectively this quarter. The proportion of customers from China still remains in double digits.

This concludes the report.

Dolphin's Research on TSMC and the Semiconductor Manufacturing Industry

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