Issues revealed from the financial report of TSMC, the world's largest semiconductor assembler

Semiconductor manufacturing is positioned as an important industry for modern technology. TSMC is one of the key companies in the chip industry supply chain. TSMC, one of the world's leading wafer foundries, has also fluctuated in line with the global semiconductor manufacturing industry cycle. Therefore, recent stock prices have also experienced major turbulence.

Therefore, it is important to carefully analyze how TSMC's financial reports should be interpreted and how the company's position should be determined within the semiconductor industry's performance cycle. Let's first focus on the following metrics: revenue growth rate and gross profit margin, revenue structure, capital expenditure, and cash flow.

In cyclical industries such as semiconductors, changes in profit growth rate and profitability are important indicators for determining the direction of the cycle. If the profit growth rate continues to accelerate and profitability indicators such as gross profit margin also continue to improve, it is generally a sign of a period when the economy is improving. The opposite can also be determined in the same way.

Looking at changes in earnings, after experiencing a decline for 3 consecutive quarters, TSMC saw revenue growth of 10.2% in the 3rd quarter of 2023 compared to the previous quarter, and finally stopped the decline. However, compared to the same period last year, TSMC's revenue is still down more than 10%.

TSMC's sales calculation method is the product of the quantity of products shipped by the price. Judging from the shipment volume in the 3rd quarter of 2023, TSMC is still declining compared to the previous quarter. The increase in sales is mainly due to an increase in average sales prices.

TSMC's gross profit margin for the third quarter of 2023 continued to stagnate and recover. The increase in profit for the quarter was modest, with an increase of only 0.2 percentage points compared to the previous quarter. There is still room for improvement compared to 60.4% in the same period last year.

Overall, TSMC's quarterly sales and gross profit margin have remained stable. The bottom of the business cycle may have been reached, and there is a possibility that demand is recovering. However, both of these indicators have declined compared to the same period last year, and it cannot be said that the semiconductor industry's overall business cycle will recover soon. Sales and gross profit margins must continue to be examined to determine the recovery of the entire industry's business cycle.

From an end product perspective, TSMC's revenue is mainly dominated by smartphones and high-performance computing, which account for approximately 80% of the company's revenue.

In the third quarter of 2023, TSMC's high performance computing revenue share declined slightly. Meanwhile, revenue share from smartphones stopped declining and rebounded. That increased from 33% in Q2 to 42%, and we can see that demand for smartphones has recovered somewhat. In the future, let's continue to pay attention to changes in the smartphone market demand cycle and its impact on TSMC's performance.

From the perspective of semiconductor chip manufacturing process technology, TSMC's revenue can be divided into categories with minimum conductor widths below 7 nm and 7 nm or more. Generally, as chip manufacturing processes become more detailed, the level of technology required is more advanced. TSMC, the world's most advanced wafer foundry manufacturing company, currently derives most of its revenue from relatively technologically advanced 7nm and smaller processes.

In the previous quarter, TSMC's revenue streams from 7nm and below manufacturing processes were 5nm and 7nm, but they were gradually shifting from 7nm to more advanced 5nm processes. By the third quarter of 2023, TSMC's 3nm manufacturing technology had entered mass production, accounting for approximately 6% of overall revenue.

In the coming quarter, along with the release of new iPhones and the launch of the latest high-end models in the Android industry, TSMC's 3nm manufacturing technology revenue will further increase, which is likely to contribute to the company's revenue growth.

TSMC is a global leader in post-processing (wafer foundry) for semiconductor components. It is the second-largest company in the entire chip industry chain in terms of market value after Nvidia, and it has always had an dominant position in the industry until now, but it must always maintain a technical lead in order to protect it. Advances in the chip foundry industry are constantly evolving towards more advanced process technology, as shown by the famous Moore's Law. If TSMC relaxes its efforts, there is a risk that it will lag behind competitors such as Samsung Electronics. If that happens, there is a possibility that its position in the industry will decline like a ship that defies backflow.

The development of new manufacturing process technology requires not only research and development costs, but also new production lines to support production capacity. To that end, TSMC will need a large investment. The company's cumulative capital expenditure from 2006 to 2022 is as high as NT$5.7 trillion at TSMC. Meanwhile, net profit for the same period was approximately NT$5.1 trillion. Capital expenditure exceeds net profit. As a result, TSMC's cumulative free cash flow during this period was approximately NT$3 trillion, which is less than 60% of total net profit.

Free cash flow is a very important evaluation indicator in many valuation models, and TSMC's free cash flow is far lower than net profit, and there is a possibility that it will adversely affect its valuation and long-term stock price performance.

Regarding capital expenditure, in the short term, the attitude of companies towards industry cycles can be observed. Generally, if a company determines that the cycle is declining, it may reduce capital expenditure. On the other hand, if we determine that the cycle is continuously rising, we may continue to increase capital expenditure. Over the past few quarters, TSMC's capital expenditure has continued to decline. We can continue to observe changes in the company's capital expenditure in the future.

In the long run, TSMC's capital expenditure trends may relate to technology trends in wafer manufacturing. If Moore's Law completely loses its effect in the future and the chip process loses room for further progress, TSMC's capital expenditure growth trend may also slow down. However, at that time, TSMC will reach its limit, competitors will gradually catch up, and competition may intensify. TSMC's cash flow may improve, but there is a possibility that gross profit margin will decline, and at that time, different competition and evaluation logic will be created.

Finally, while TSMC's sales and gross profit margin have recovered slightly from the previous quarter, they have yet to reach the same level as the same period last year. Cycle recovery requires continued observation. In terms of revenue structure, a recovery in the smartphone market may result in positive changes in TSMC's earnings. Also, mass production of TSMC's 3nm technology is likely to further drive TSMC's revenue growth.

TSMC's capital expenditure has a significant impact on free cash flow, which in turn affects valuation. We can observe changes in capital expenditure from both a short-term perspective and a long-term perspective.