TSMC: record quarter is just the beginning

Sales at Taiwan Semiconductor Manufacturing Co, the world’s largest contract chipmaker, rose 28 per cent to a record $13.3bn in the second quarter. The global chip shortage may have peaked but demand for TSMC products has not.

Apple, TSMC’s biggest customer, is reported to have asked suppliers to increase new iPhone output plans by up to a fifth this year, equivalent to 90m next-generation smartphones. But TSMC’s growth is not simply down to the pandemic-led surge in sales of work-from-home devices such as smartphones. There is also a global increase in investment in next-generation technologies such as artificial intelligence and smart cars. The company is in the midst of a drive to increase automotive chip production by 60 per cent this year.

The flip side of such strong demand is the need for increased capacity at plants, which comes at a steep price. TSMC has announced plans to spend up to $28bn this year and is set to invest $100bn over the next three years. That heavy capex spend has already begun to show up in margins. Gross margins fell 3 percentage points to 50 per cent in the second quarter. Free cash flow halved to $733m. Profit, which rose 11 per cent to $4.8bn, was just short of market expectations. There will be further margin pressures as production ramps up.

Meanwhile, TSMC shares trade at 27 times forward earnings, double that of US rival Intel.

Much of the chipmaker’s near-term growth has already been priced in. Still, there is little uncertainty about long-term demand. Competition in the chips that it makes is limited thanks to high barriers to entry. The global supply glut that has historically followed extended stretches of rapid capacity increase may not emerge this time around. Nervous clients, who have already experienced the crippling effects of a chip shortage, are hoarding chips. Default inventory levels are much higher than they were before the pandemic. A lasting change in purchasing habits could support further upside in TSMC’s share price.