In October 2024, as the leading wafer foundry, the market cap is nearly $1 trillion! How is TSMC's performance viewed?

The semiconductor chip industry is known as the pearl of modern technology. Meanwhile, it is one of the key enterprises in the chip industry supply chain. $Taiwan Semiconductor (TSM.US)$ As a leading global wafer foundry, TSMC's performance has fluctuated along with the global semiconductor industry cycle, and the company's stock price has experienced significant volatility in recent years. Recently, benefiting from the continuous strong demand for data centers and the boost in high-end mobile chip demand from Apple's price reduction promotions, TSMC's stock price has shown very strong performance, with the market cap reaching near a trillion dollars.

Recently, TSMC will release its latest quarterly report. Every time the company releases its financial performance, it may also represent a good trading or investment opportunity. Prior to this, investors need to understand how to interpret its financial reports.

So, how should we interpret TSMC's performance? And how can we judge the position of its performance cycle? Let's pay attention to these indicators: revenue growth rate and gross margin, revenue structure, capital expenditure, and cash flow.

1. Revenue Growth Rate and Gross Margin

For industries with cyclical characteristics, changes in revenue growth rate and profitability are important references for judging the direction of the cycle. When revenue growth rate continues to accelerate and profitability indicators like gross margin keep improving, it is generally during a high period of the cycle and vice versa.

Looking at the revenue growth rate, we can see that after experiencing three consecutive quarters of sequential decline, TSMC finally stopped the decline in Q3 of 2023, with a 10.2% increase compared to the previous quarter. In 2024 Q2, TSMC's revenue continues the rebound trend, with a 40% year-on-year growth and a sequential increase of 13.7%.

TSMC calculates revenue by multiplying product shipments by prices. In Q2 of 2024, TSMC's significant revenue growth was due to the simultaneous increase in product shipment volume and prices.

Benefiting from the demand for AI, TSMC's shipment volume in the second quarter increased by about 3% compared to the previous quarter. With the increase in revenue from high-end processes such as 3nm, TSMC's average selling price also rose, increasing by about 7% compared to the previous quarter. The synergy of volume and price also drove revenue growth.

In terms of gross margin, TSMC's gross margin in Q2 2024 is approximately 53.2%, still remaining at a relatively low level. This may be due to the impact of higher depreciation expenses brought about by the mass production of 3nm. However, driven by the significant increase in average selling price, TSMC's gross margin has improved relative to the previous quarter's 53.1%.

Overall, TSMC's revenue growth has accelerated, perhaps indicating a recovery in industry demand. The slight rebound in TSMC's gross margin level may also suggest a turnaround in its profitability. Moving forward, we can observe whether its revenue can maintain a high growth rate in future quarters and if its gross margin level can continue to improve to determine the situation of its cyclical recovery.

2.Income Structure

In terms of revenue structure, TSMC's revenue is mainly driven by smartphones and high-performance computing, both accounting for over 80% of the company's revenue.

In 2023 Q3-Q4, the proportion of smartphone revenue rebounded for two consecutive quarters, increasing significantly from 33% in the second quarter to 43%, to a certain extent indicating the recovery of the smartphone market demand. However, in 2024 Q1-Q2, due to changes in the market share of low-end smartphone chips, TSMC's smartphone revenue proportion declined. Conversely, benefiting from the demand for data centers and AI, TSMC's high-performance computing division achieved a record high revenue share in 2024 Q2 compared to the past few quarters.

Moving forward, we can continue to observe the cyclical changes in smartphone market demand and the sustainability of data center demand, and the resulting impact on TSMC's performance.

In terms of chip manufacturing technology, TSMC's revenue can be divided into below 7nm and 7nm and above. Generally, the lower the chip process, the more advanced the technology. As the world's most advanced semiconductor foundry, TSMC currently generates most of its revenue from relatively advanced processes below 7nm.

In the previous few quarters, TSMC's revenue from 7nm and below is mainly from 5nm and 7nm processes, gradually transitioning from the 7nm process to the more advanced 5nm process. By Q3 2023, TSMC's 3nm technology officially begins mass production, contributing about 6% of the total revenue, which further increases to 15% in Q4 2023. However, it drops to 9% in Q1 2024 due to a decrease in Apple sales, but rebounds to 15% in Q2 2024 due to an increase in Apple sales.

In the coming quarters, with the release of new Apple devices and the push for high-end chip demand from data centers, TSMC's 3nm technology may further contribute to revenue, driving income growth.

3. Capital Expenditure and Cash Flow

As a global leader in semiconductor foundry services, TSMC ranks second only to Nvidia in the entire chip industry chain market cap. Despite its prominent industry position, it must continuously maintain technological leadership. In the semiconductor foundry industry, driven by Moore's Law, advancements are continuously made in more advanced process technologies. If TSMC relaxes its efforts, it risks falling behind, potentially surpassed by competitors like Samsung Electronics in no time.

Developing new technological processes not only requires R&D expenditure but also the supporting production capacity of new production lines, leading to high capital expenditures for TSMC. From 2006 to 2023, TSMC's cumulative capital expenditure reached as high as 6.7 trillion New Taiwan dollars, while the net profit during the same period was about 6 trillion, with capital expenditures exceeding net profit. As a result, TSMC's cumulative free cash flow during this period was approximately 3.3 trillion, only about 60% of the total net profit.

In many valuation models, free cash flow is a very important valuation indicator. TSMC's free cash flow is significantly lower than its net profit, which may have a negative impact on its valuation and long-term stock performance.

In the short term, we can observe the company's attitude towards the industry cycle as an indicator for capital expenditure. Generally, if a company anticipates a downturn in the cycle, it may reduce capital expenditure, while expecting a continuous upturn in the cycle may lead to increased capital expenditure. In the previous quarters, TSMC's capital expenditures continued to decrease, but in Q1-Q2 2024, there was a rebound in its capital expenditures. Moving forward, we can continue to monitor changes in the company's capital spending.

Looking at the long term, TSMC's capital expenditure trend may be linked to the technical trends in wafer manufacturing. If Moore's Law completely loses its effectiveness in the future and the chip-making process loses room for advancement, the growth trend in TSMC's capital expenditures may slow down. However, when TSMC reaches its technological peak and competitors gradually catch up, increasing competitive pressure may lead to improved cash flow for TSMC, but the gross margin may decline. At that time, it will lead to a different set of competitive dynamics and valuation logic.

At this point, you may have some new insights on how to read TSMC's performance. It is worth mentioning that each time a star company releases its performance, it may represent a rare trading opportunity for different types of investors.

For example, if investors interpret the past performance and combine it with the latest developments and feel that a company's latest performance will release some positive signals and be bullish about the short-term stock price, they may consider going long. The way to go long could be considering buying common stock or consider buying call options, etc.

On the contrary, if investors think that a company's latest performance will not be optimistic and will put pressure on the short-term stock price, investors may consider going short. The way to go short could be considering selling short through margin trading or consider buying put options, etc.

Of course, if investors think that the long and short direction of a company's performance is not clear, but the stock price may fluctuate significantly after the performance is released, investors may consider making the volatility of the stock price long and buying both call and put options through the strategy of straddle to seize potential opportunities.

In conclusion,

TSMC's revenue has risen for two consecutive quarters, while the gross margin continues to decline. The situation of the cycle turning positive still needs further observation.

In terms of revenue structure, the continuous outbreak of AI demand may bring positive changes to TSMC's revenue. The mass production of TSMC's 3nm technology may further drive the growth of TSMC's revenue.

TSMC's capital expenditures significantly impact free cash flow, thereby affecting valuation. We can observe the changes in capital expenditures from both short-term and long-term perspectives.

Each time the company announces its performance, it may bring potential trading opportunities. Investors can consider suitable trading varieties according to their personal risk tolerance.