2023-04-20 09:24:04 ET
Summary
- TSMC reported in line Q1 2023 earnings after investors tempered expectations on weak sales numbers released earlier this month.
- Management also offered a tepid guidance for the current quarter, citing persistent macroeconomic challenges.
- Despite the stock's relative discount at current levels, which appears to have sufficiently de-risked for near-term challenges, it will likely be prudent to temper expectations over the 2H recovery narrative.
Taiwan Semiconductor's ( TSM ) stock has largely maintained its resilience in recent weeks after markets priced in tempered expectations following the release of a disappointing first quarter sales figure earlier this month. Ongoing momentum in generative AI that has likely helped maintain a sentiment lift in the stock though, despite worries that the ongoing inventory correction cycle has yet to bottom given stiffening macro challenges on TSMC’s near-term demand environment. And the Taiwanese foundry’s release of in line first quarter earnings today (April 20) has likely also assuaged some of investors’ concerns about its bumpy recovery ahead of an ongoing cyclical downturn, as observed via the shares’ resilience in pre-market trading.
With markets having already been expecting weak first quarter results from TSMC heading into the company’s latest earnings release, the stock’s early-month pullback has likely adjusted for further deterioration in the foundry’s near-term demand environment, with focus now diverting towards expectations for restored recovery momentum heading into the second half and next year. Given structural growth trends for TSMC remain largely intact despite transient macroeconomic challenges, with recent interest in generative AI further bolstering longer-term demand for high-performance computing (“HPC”) hardware in which the company is a critical enabler of, the stock’s recent moderation in adjustment for investors’ tempered near-term expectations creates a sufficiently de-risked opportunity for longer-term upside participation.
Admittedly, volatility will likely remain the near-term theme for TSMC shares to reflect investors’ expectations for the underlying business to work through continued cyclical weakness that we view to have only just started to flow upstream , which could delay optimism for a second half recovery to next year instead. But there will likely be a greater shift in focus towards anticipation for more durable recovery momentum heading into 2024, as both fundamentals and relative share performance at TSMC are expected to find a bottom in the coming months.
1Q23 Earnings Overview
TSMC reported a first quarter sales increase of 3.6% y/y to NT$508.63 billion ($16.7 billion), which came in at the lower range of management’s guidance and missed consensus estimates for the second consecutive quarter. Declines were evident in consumer-centric verticals, with sales dragged down primarily by weakness in smartphone applications, partially offset by automotive demand as the industry recovers from acute supply chain constraints.
TSMC 1Q23 Q/Q Revenue Growth by Platform (TSMC 1Q23 Earnings Presentation)
Earnings came in at NT$7.98 per share, or $1.31 per ADR unit, slightly beating consensus calls for $1.20 per ADR unit. The results continue to corroborate a slow demand environment in the broader semiconductor sector as the consumer braces for further economic deterioration. Hampered ramp up of productions due to softening demand has also likely compounded pains from persistent inflationary pressures on profitability. The company’s gross margins for the quarter came in at 56.3%, which contracted by almost six percentage points from the prior quarter’s 62.2%. Net profit margin also declined by almost seven percentage points, dragged primarily by rising opex and production costs.
Looking ahead, management expects a continuation of persistent macroeconomic challenges experienced over the past two quarters, guiding revenue between $15.2 billion (-16.5% y/y; -9.0% q/q) and $16.0 billion (-12.0% y/y; - 4.2% q/q). The stock’s resilience immediately following the earnings release suggests investors’ expectations that have already been tempered following signs of continued deterioration to TSMC’s demand environment earlier this month, with management’s tepid guidance for the second quarter having sufficiently de-risked for the anticipated macro-driven weakness to come. In the meantime, gross margins are expected to decline further, though at a decelerated pace, between 52% and 54% during the current quarter, with operating profit margin between 39.5% and 41.5% - likely the result of persistent cost pressures, partially offset by easing ramp up costs associated with new process technologies introduced in 2020 (5nm) and late 2022 (3nm).
Further Weakness on the Horizon
TSMC’s first quarter results were a continuation of late-year weakness observed in 2022 as impacts of an ongoing inventory adjustment start to flow upstream. Accelerating revenue declines observed at TSMC in recent months imply that the ongoing cyclical downturn in the broader semiconductor industry has yet to find a bottom, with persistent inflationary pressures and rising interest rates weighing further on consumption. This is further corroborated by a worsening decline in global PC shipments, which fell by 30% y/y during the first quarter, accelerating from declines of 28.5% in the prior quarter. And TSMC’s lead customer, Apple ( AAPL ), was hit hardest after maintaining relative resilience over the past year – shipments of the Mac line-up saw a 40.5% y/y decline during the first quarter, the worst slowdown in more than two decades.
A similar extent of weakness is likely to persist over the coming months, given the typical seasonality slowdown for June quarters, alongside expectations for continued deterioration in the consumer.
Our first quarter business was impacted by weakening macroeconomic conditions and softening end market demand, which led customers to adjust their demand accordingly…Moving into the second quarter 2023, we expect our business to continue to be impacted by customers’ further inventory adjustment.
Source: TSMC 1Q23 Earnings Press Release
Specifically, TSMC’s core market in the U.S. has continued to exhibit signs of cooling consumption . U.S. retail sales fell for a second consecutive month in March by 1% y/y, led primarily by a slowdown in demand for electronics and vehicles – two primary application use cases for TSMC-made hardware. Decelerating debit and credit card spending in recent months also indicate further weakness in consumption, implying the added pinch of declining employment and income on top of persistent inflation and rising interest rates.
Taken together, TSMC likely faces an increasingly challenging demand environment in the near-term, which is consistent with expectations for further declines in Taiwanese exports in the current quarter. The world’s largest chip manufacturer is a “major contributor to [Taiwan’s] economy. With exports from the island expected to decline further by as much as 20% y/y in April, accelerating from March’s 19% drop, and 15% for the “entirety of the second quarter”, TSMC’s fundamentals are likely to remain subdued over the coming months. This is also consistent with ASML’S ( ASML ) – the world’s largest chipmaking equipment manufacturer and major supplier for TSMC – recent observation of reduced bookings during the first quarter that will likely persist for a while longer as downstream consumer demand weakness continues to impact upper stream components of the broader semiconductor supply chain.
2H23 Expectations
Market participants are largely expecting gradual signs of recovery in the third quarter as downstream customers work through what might become the end stages of a year-long inventory glut in the coming months, alongside a seasonality boost driven by back-to-school and holiday demand. The continued ramp up of new technology shipments in the industry – including Nvidia’s ( NVDA ) H100 GPUs and TSMC’s industry leading 5nm process – is also expected to reinforce the second half recovery narrative.
Specifically, Nvidia’s H100 data center GPUs based on its latest Hopper Architecture has benefited from growing momentum in the development of generative AI, with outsized demand pushing prices in the secondary market beyond $40,000 on online marketplaces like eBay ( EBAY ), or about 4x the chip’s MSRP of about $10,000 apiece. This accordingly makes a favourable tailwind to TSMC’s continued ramp up of its 5nm process, which the manufacturing of the H100 GPUs are based off of. During the first quarter, the 5nm process technology had contributed to 31% of TSMC’s wafer revenue, in line with the mix observed during the fourth quarter and up from 26% for full year 2022. And the mix of wafer revenues generated from advanced technologies (i.e. 7nm and more advanced) is expected to accelerate further as they continue to ramp through the longer-term while transient macro headwinds moderate over time.
However, we remain incrementally cautious on the second half recovery narrative given the weakening consumer as discussed in earlier sections, which will inevitably weigh on visibility over TSMC’s near-term demand environment. In line with our previous discussion on the stock, we believe upper stream components of the broader semiconductor sector – including foundries like TSMC – will continue to experienced delayed impacts from the ongoing cyclical downturn. Anticipation for recovery to pickup pace in the second half for downstream components like fabless chipmakers and PC makers are unlikely to place an immediate impact on chip manufacturers like TSMC, with focus shifting largely towards expectations for more evident improvements entering 2024. Specifically, as inventory levels normalize across the supply chain after the yearlong glut, ensuing demand recovery will likely stay modest in the second half.
More prominent improvements are instead expected heading into the following year, which will drive a more durable rebound buoyed by structural longer-term growth drivers that have largely stayed intact while transient macroeconomic challenges subside. This includes key secular trends like generative AI, which is expected to further expand the TAM in cloud computing over the coming years, and inadvertently drive greater demand for TSMC’s cutting-edge process technologies critical to relevant supporting hardware.
Demand for AI services is expected to offer strong tailwinds to hyperscale installations and the entire value chain that feeds into the modern data centers – including storage and networking components. AI processors are expected to be a $38 billion market by 2026, up nearly 4x from 2022 levels. 4 The opportunity for specialized semiconductor players is massive.
Source: “ Digital Economy Discovers a Potential Frontier for Growth Thanks to Generative AI ”, Global X ETF
The Bottom Line
Given continued weakness expected in TSMC’s near-term demand environment, alongside a worsening consumer based on recently released economic data, we remain incrementally cautious over management’s reiterated confidence in a solid second half recovery. It appears cyclical challenges to the semiconductor sector have only really just started to dent performance among upper stream components like chip manufacturers, thus a sustained recovery is not expected to become evident until at least 2024 after lower stream components across the value chain, like fabless chipmakers and PC makers, demonstrate restored momentum to demand.
But with TSMC's stock now trading substantially below its historical levels at under 16x estimated earnings, with its rebound this year still trailing the broader Philadelphia Semiconductor Index’s ( SOX ) upsurge year-to-date by about four percentage points, concerns over the anticipated near-term challenges to the underlying business’ fundamentals alongside cautious optimism over the second half recovery narrative have likely been priced in already. This is also consistent with the stock’s resilience immediately following the release of first quarter earnings results, alongside the tepid second quarter guidance, implying the shift in investors’ focus towards anticipated improvements to the demand environment in the latter half of the year instead. Although the anticipation for further deterioration to TSMC’s operating environment due to transient macro challenges will likely drive incremental weakness to the stock over the near-term, ensuing pullbacks from currently discounted levels – which we view to have sufficiently de-risked for the industry-wide cyclical downturn – would make a compelling entry opportunity to partake in longer-term upside potential buoyed by structural growth trends that remain intact.
For further details see:
Taiwan Semiconductor Q1'23 Review: Tempering Expectations Ahead