TSMC's Advanced Tech And Global Expansion Drive Future Revenue Despite Margin Challenges

Key Takeaways

• Strong demand for advanced technologies in smartphones and AI, combined with increased server AI processor demand, could drive revenue growth and enhance net margins.
• International expansion with new fabs and investment in advanced processes may boost long-term growth, despite initial cost challenges.
• Increasing costs and inefficiencies, along with foreign exchange variability, pose risks to TSMC's margins and profitability.

Catalysts

About Taiwan Semiconductor Manufacturing

• 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.

What are the underlying business or industry changes driving this perspective?

• TSMC is witnessing strong demand for advanced 3-nanometer and 5-nanometer technologies, driven by smartphone and AI applications, which is expected to continue into the foreseeable future, likely boosting revenue growth.
• The company has increased its capital expenditures, anticipating future growth opportunities, with a significant portion allocated for advanced process technologies. This investment could enhance future earnings through technological leadership and market share expansion.
• A substantial demand increase for server AI processors, forecasted to contribute significantly to revenue, supports TSMC's growth outlook. This can positively impact revenue and operational leverage, enhancing net margins.
• TSMC's international expansion, with new fabs in Arizona, Japan, and Germany, could increase capacity and provide strategic flexibility, potentially leading to long-term revenue growth and diversification of earnings sources despite initial cost dilutions.
• The successful execution and efficiency improvements in advanced packaging could enhance profitability, with expected growth in this segment surpassing corporate average growth rates, indicating a potential boost in overall earnings margins.

Taiwan Semiconductor Manufacturing Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Taiwan Semiconductor Manufacturing's revenue will grow by 15.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 39.1% today to 39.4% in 3 years time.
• Analysts expect earnings to reach NT$1606.5 billion (and earnings per share of NT$62.07) by about November 2027, up from NT$1037.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting NT$1917.0 billion in earnings, and the most bearish expecting NT$1426.1 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 27.7x on those 2027 earnings, up from 25.6x today. This future PE is lower than the current PE for the US Semiconductor industry at 30.1x.
• Analysts expect the number of shares outstanding to decline by 0.07% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.6%, as per the Simply Wall St company report. /li>

Taiwan Semiconductor Manufacturing Future Earnings Per Share Growth

Risks

What could happen that would invalidate this narrative?

• The increasing electricity prices in Taiwan, along with other inflationary costs, are expected to impact TSMC's gross margin by at least 1%, potentially reducing overall profitability.
• Overseas fabs, particularly in Arizona and Japan, are anticipated to dilute TSMC's gross margin by 2-3% per year due to their smaller scale and higher costs, affecting net margins.
• The ongoing ramp-up and conversion costs from N5 to N3 technologies, coupled with preparation costs for N2, could strain cash flow and reduce net earnings in the short term.
• Rising inventory days, due primarily to prebuilding of N3 and N5 wafers, indicate potential inefficiencies or slower-than-expected sales, which could negatively impact cash flow and earnings.
• Variability in foreign exchange rates presents a risk, as a 1% movement can impact TSMC's gross margin by 40 basis points, affecting both revenue and net margins.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of NT$1382.28 for Taiwan Semiconductor Manufacturing based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NT$1600.0, and the most bearish reporting a price target of just NT$1170.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be NT$4075.4 billion, earnings will come to NT$1606.5 billion, and it would be trading on a PE ratio of 27.7x, assuming you use a discount rate of 7.6%.
• Given the current share price of NT$1025.0, the analyst's price target of NT$1382.28 is 25.8% higher.
• 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.