Six major risks of TSMC's gross profit margin as high as 59.1%!

TSMC held a 2022 second quarter corporate briefing on July 14, presenting gorgeous financial figures and showing a positive fighting spirit of "overflowing confidence" in the face of all challenges. However, TSMC lightly skipped the six major risks it faces!

As the global stay-at-home economy comes to an end, TSMC, the leading wafer manufacturing company, has encountered fluctuations in 2022. In the cloudless market, under multiple variables such as inflation, the Russia-Ukraine war, and a tightening consumer market, the stock price has fallen from a high of NT$688 in January 2022 to NT$433 in July. The shrinkage was so large that the legal briefing held on the 14th attracted special attention from the outside world.

"TSMC's gross profit margin grew by 350 basis points in a single quarter, reaching 59.1%," Chief Financial Officer Huang Renzhao gave an incredible figure at the beginning! What does 59.1% mean? This figure is not only higher than the general forecast of foreign investors and TSMC's forecast of 58% in the previous quarter, but also the highest single-quarter gross profit margin of TSMC since its listing 27 years ago!

Exploring the factors that contributed to the ultra-high profitability of 59.1%, we can find that the three main reasons for the increase in total revenue are the R&D and capacity expansion of advanced processes, the full utilization of overall capacity, and the price increase that started in the second half of last year. In addition, the advanced processes that are currently being mass-produced have entered the harvest period, cost optimization is being implemented downwards, and the diversified technology portfolio has put the gross profit margin on the growth track.

More importantly, the change in the exchange rate in the second quarter brought a stronger tailwind to TSMC. TSMC's actual gross profit margin in the second quarter exceeded the high end of the previous quarter's forecast by 58%, because it was based on the exchange rate assumption of NT$28.8 to 1 US dollar, but the actual exchange rate in the second quarter was NT$29.42 to 1 US dollar, which was about 90 basis points higher than the previous estimate.

TSMC team estimates that assuming a slightly favorable exchange rate will be offset by higher inflation, TSMC's gross profit margin in the third quarter of 2022 will decrease by 60 basis points quarter-on-quarter, with a median outlook of 58.5%. However, if the forecast is optimistic, it will reach 59.5%, with a great chance of challenging the 60% mark. "If we exclude the impact of uncontrollable exchange rates, we still believe that a long-term gross profit margin of more than 53% is achievable," said Huang Renzhao.

TSMC's revenue in the second quarter of 2022 was NT$534.14 billion, up 8.8% from the previous quarter and 43.5% from the previous year. Its gross profit margin was 59.1%, up 3.5 percentage points from the previous quarter and 9.1 percentage points from the previous year. Its net profit after tax reached NT$237.03 billion, with net profit per share of NT$9.14.

▲ The Q3 2022 figures are the high-end values ​​predicted by TSMC (after-tax net profit margin is not predicted).

Looking at the profit momentum, in terms of technology platform categories, last quarter, high-performance computing (HPC) sales accounted for 41%, surpassing smartphones, the traditional largest source of revenue, for the first time. But last quarter, the difference between the two was only 1 percentage point, and it remains to be seen which is more important. However, this quarter, the sales share continues to widen, with high-performance computing accounting for 43% and smartphones down to 38%. This shows that the prediction that high-performance computing platforms will become TSMC's main revenue pillar has come ahead of schedule.

▲ High-performance computing platform becomes TSMC's largest technology platform. (Source: TSMC)

This earnings conference was originally expected to be gloomy due to the volatile market conditions and sluggish stock prices. However, TSMC unexpectedly presented a dish of exquisite financial report figures, which made the atmosphere somewhat "cheerful".

At the briefing, although the management team could not speak directly to shareholders, they repeatedly mentioned "we are confident". In the 1.5-hour meeting, Chairman Liu Deyin said "confident" twice, and President Wei Zhejia said it seven times, as if to give the stock price a shot in the arm. But beneath the gorgeous financial report figures, it can be found that TSMC's management team lightly overlooked six major risks:

1. Supply chain inventory reorganization will continue until the first half of 2023:

During the two years when the stay-at-home economy was booming, upstream IC design factories (chip brand factories) rushed to increase production capacity and increase inventory to seize the market. However, this year, the economy began to decline, and the terminal consumer market was weak, which slowed down the inventory digestion speed. Therefore, upstream factories tended to be conservative and the probability of placing orders decreased.

TSMC observes that inventory levels will decline in the second half of 2022, and the phenomenon of excessive inventory will take several quarters to rebalance to a healthier level, which is expected to last until the first half of 2023. This means that TSMC's order acceptance speed will continue to slow down in the next six months to a year.

2. Electricity prices become a new focus in 2023:

When discussing profitability, "electricity costs" were mentioned for the first time. According to the July 1 electricity price increase, the average electricity price increased by 8.4%, of which the high-voltage and ultra-high-voltage industrial electricity users increased by 15%. It is estimated that TSMC's electricity bill will increase by 4 billion yuan a year. The earnings conference did not directly answer the electricity bill issue, but the considerable figure will be reflected in the next financial report.

3. Capital expenditures in 2022 have not been reached and equipment has not been in place:

At the end of last year, TSMC announced that its capital expenditure in 2022 would reach US$40 billion to US$44 billion, 30% higher than the US$30 billion in 2021. At that time, it was planned to be used to build new factories (the United States, Japan, Hsinchu Baoshan, Kaohsiung) and expand old factories (Tainan, Hsinchu, Nanjing). "We expect that part of this year's capital expenditure will be moved to 2023. We are helping machine suppliers to face supply chain challenges and identify key chips that affect machine delivery," said Wei Zhejia, adding that they will allocate their own production capacity to produce key chips for the ordered machines to speed up machine delivery.

4. Cost issues in US factories may be troublesome:

Regarding the progress of the US factory construction, recently, US employees wrote to online media to complain about the working atmosphere, which also became the overtone of the Q&A session of the legal briefing. Chairman Liu Deyin said that the cost of the US factory is indeed higher than expected, but the demand for production capacity from US customers is very strong. With this support, they will discuss with the US government and do their best to reduce costs.

5. The advanced process 2nm is very new and complex:

Wei Zhejia said that the progress of the 3nm process is in line with expectations and will be mass-produced in the second half of 2022 with a good yield. He also revealed the current development status of 2nm, "2nm technology development is proceeding as planned, with trial production expected in 2024 and mass production in 2025." After careful and extensive evaluation and research and development, TSMC's 2nm will adopt a "nanosheet transistor" (GAA) architecture, which will increase the speed by 10%-15% at the same power consumption, or reduce power consumption by 25%-30% at the same speed, and increase the logic density by 20% compared to 3nm (N3E).

The so-called "nanosheet transistor" changes the way the fins are arranged, from standing vertically to stacking horizontally, making the current channel wider. Therefore, the 2nm process will be different from the earlier generations. It is a new process in the new field. Whether it can maintain the excellent process of the 7nm, 5nm, and 3nm families is a real challenge.

6. Where is the mysterious power behind the expansion of special processes?

TSMC recently chose to invest resources to increase the production capacity of "special processes". Foreign investors have raised questions about why TSMC chose to increase the production capacity of special processes instead of the more tight "mature process" production capacity? What new applications have driven TSMC's confidence in expanding production?

Wei Zhejia responded, "This wave of expansion of special process production is indeed on a scale never seen before. The main reason is that in the past few years, special processes have not been expanded in production, and at most have been upgraded. But whether it is advanced or mature process products, they all require special process product support, so this expansion is still due to customer demand."

Such a bold resource allocation, "How confident are you?" the legal representative asked three times. "Very, Very," Wei Zhejia responded to the legal representative briefly and domineeringly. At this time, both of them laughed at the same time, which was a very interesting moment in this legal briefing.

However, is it worth investing resources to expand special processes? The capacity requirements brought by new applications are ultimately unknown, or it can be said to be a risk that needs to be observed.