Margin Erosion And Geopolitical Tensions Will Undermine Profitability

Key Takeaways

• Overseas expansion, regulatory costs, and sustainability investments are eroding margins and diminishing TSMC's long-term profitability and capital efficiency.
  
• Customer concentration and geopolitical risks threaten revenue stability, with demand volatility and in-house chip production by clients posing further top-line challenges.
  
• Strong demand for advanced chips, geographic diversification, and technology leadership support TSMC's resilient revenue growth, margins, and long-term earnings stability.

Catalysts

Manufactures, packages, tests, and sells integrated circuits and other semiconductor devices in Taiwan, China, Europe, the Middle East, Africa, Japan, the United States, and internationally.

• Margin dilution from overseas expansion is accelerating, with management explicitly guiding that the margin hit from ramping overseas capacity, including the massive Arizona project, will widen from 2 to 3 percent annually in early stages to 3 to 4 percent by 2030, driven by cost inflation and tariff-related expenses. This sustained margin erosion is likely to significantly compress net margins and lower long-term profitability.
  
• The global push for regionalization and onshoring-manifested by increasing capital commitments in the United States, Japan, and Europe-reflects growing customer and government demands for supply chain security, but this undercuts the inherent cost efficiencies and scale advantages of concentrating manufacturing in Taiwan. Over time, this forces TSMC to operate with persistently higher capital expenditures and operating costs, lowering its historical returns on invested capital.
  
• An escalation in geopolitical tensions and fragmented globalization is increasing the risk of both cross-strait disruptions affecting Taiwan-based fabs and retaliatory tariffs or technology bans between the U.S. and China. These dynamics pose a direct threat to TSMC's ability to maintain its global market share and stable customer relationships, potentially resulting in reduced order volumes and volatile long-term revenue streams.
  
• Intensifying environmental regulations and worldwide efforts to improve sustainability standards will require TSMC to invest heavily in cleaner, resource-intensive manufacturing, adding to already ballooning capital expenditures. These costs are unlikely to be fully offset by wafer pricing, compounding the drag on net margin expansion.
  
• A heavy revenue dependency on a small group of advanced node customers (notably Apple, Nvidia, and AMD), combined with a plateauing smartphone and PC demand environment and the rising threat of in-house chip manufacturing by major clients, raises the risk of major order instability. Should key customers shift their sourcing or scale back external foundry engagements, TSMC faces outsized top-line risk and a downturn in earnings growth.

Taiwan Semiconductor Manufacturing Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Taiwan Semiconductor Manufacturing compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Taiwan Semiconductor Manufacturing's revenue will grow by 15.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 41.7% today to 40.4% in 3 years time.
• The bearish analysts expect earnings to reach NT$1956.3 billion (and earnings per share of NT$75.46) by about July 2028, up from NT$1309.3 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.5x on those 2028 earnings, down from 22.4x today. This future PE is lower than the current PE for the US Semiconductor industry at 24.2x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.95%, as per the Simply Wall St company report.

Taiwan Semiconductor Manufacturing Future Earnings Per Share Growth

Risks

• The sustained and structurally growing global demand for AI accelerators, high-performance computing, and advanced process nodes underpins TSMC's revenue growth potential, as seen in its guidance for AI-related revenue to double and expectations of mid-40% compound annual growth rates for the next five years, supporting continued expansion of both revenues and earnings.
  
• TSMC maintains consistent technology leadership with rapid transitions to advanced nodes such as 3-nanometer, 2-nanometer, and the upcoming A16, reporting higher tape-out numbers for 2-nanometer compared to its prior launches and thus bolstering long-term order visibility and pricing power that protect net margins.
  
• The company's geographic diversification with substantial investments in the U.S., Japan, and Europe reduces geopolitical concentration risk and enables TSMC to capture onshoring incentives and regional demand shifts, enhancing the resilience of its revenues and supporting future growth in the face of global supply chain dynamics.
  
• Management repeatedly emphasized robust customer demand and long-term contracts from diversified sectors-including AI, automotive, and specialty technology-reducing reliance on a few customers and stabilizing cash flow, which raises the likelihood of steady or growing earnings over time.
  
• TSMC's capital expenditures remain directly linked to anticipated long-term growth, and its ability to negotiate value-based pricing with customers, especially for overseas fabs with geographic flexibility, reinforces the company's projection of maintaining industry-leading gross margins of 53% or higher despite near-term dilution, supporting long-term profitability and shareholder returns.

Valuation

• The assumed bearish price target for Taiwan Semiconductor Manufacturing is NT$961.09, which represents two standard deviations below the consensus price target of NT$1264.31. This valuation is based on what can be assumed as the expectations of Taiwan Semiconductor Manufacturing's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NT$1700.0, and the most bearish reporting a price target of just NT$950.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be NT$4843.9 billion, earnings will come to NT$1956.3 billion, and it would be trading on a PE ratio of 16.5x, assuming you use a discount rate of 9.0%.
• Given the current share price of NT$1130.0, the bearish analyst price target of NT$961.09 is 17.6% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.