TSMC, a trillion-dollar company, is about to face a financial report test, here are seven key issues to focus on

Next Tuesday, the global chip manufacturing giant Taiwan Semiconductor will announce its second-quarter financial report.

According to media compilation data, the market currently expects the company's second-quarter revenue to increase by 36% year-on-year, marking the fastest growth since the fourth quarter of 2022.

Amid strong optimism, overnight in the U.S. stock market, Taiwan Semiconductor's stock price continued to hit historic highs, with the company's market value briefly surpassing $1 trillion.

Analysts Gokul Hariharan and Robert Hsu from Morgan Stanley, in a research report released on July 7th, maintained a "buy" rating on Taiwan Semiconductor and raised its 2025 target price to NT$1080.

Regarding the financial report, Morgan Stanley expects that Taiwan Semiconductor's second-quarter revenue will be $20.5 billion, with a gross margin of 53%; third-quarter revenue is expected to grow by 12%-15% quarter-on-quarter, reaching $23.3 billion, with a slight decrease in gross margin to 52.8%.

In the long term, the report predicts that Taiwan Semiconductor's revenue in U.S. dollars for the full year 2024 will increase by approximately 27%, and is expected to grow by 24% in 2025, mainly driven by strong growth in AI chip manufacturing-related revenue, the development of edge AI, and the increasing adoption of N3 nodes by non-Apple customers.

The report also forecasts that by 2025, due to the price increases of N3, N5, and CoWoS nodes, as well as the cyclical nature of other process nodes, the gross margin is expected to significantly increase to 58%.

Seven Focus Points for this Financial Report

In addition to financial data, Morgan Stanley points out that investors will focus on seven issues in Taiwan Semiconductor's upcoming financial report.

1. Will Taiwan Semiconductor raise its revenue guidance and capital expenditure guidance for 2024?

The report predicts that in the upcoming earnings call, Taiwan Semiconductor will raise its revenue guidance from a lower 20% range level (e.g., 18%-20%) to a higher 20% range level (e.g., 19%-21%).

However, it is expected that Taiwan Semiconductor will not raise its capital expenditure guidance, as this year's actual capital expenditure may reach the upper limit of the guidance due to continued investment in N2 and advanced packaging.

2. What are the upside and downside risks to revenue growth in 2024/2025?

Morgan Stanley predicts that Taiwan Semiconductor's demand for AI accelerators will be more positive, especially benefiting from the strong growth of NVIDIA's GB200 and the sustained strong demand for ASIC (mainly Broadcom's TPU) chips, expecting continued strong demand for AI chip manufacturing.

Furthermore, the market demand for high-end smartphones will further drive revenue growth for the N3 node process. The report predicts that Taiwan Semiconductor's N3 node capacity utilization rate will reach 110-115% in the second half of 2024, with N4/N5 capacity utilization rate also approaching 100% However, the continuous low utilization rate of the relatively backward N7 node process is a potential downside risk.

3. Will TSMC convert N7 to other process nodes to address the current low utilization rate?

Technically, TSMC can convert N7/N6 to newer process nodes, but this may not be very efficient.

The report suggests that TSMC may wait for the next wave of demand growth for N7/N6 in the next 12-18 months before making a final decision on converting capacity.

4. Will TSMC raise prices for advanced nodes and lower prices for older nodes?

The report indicates that the prices for advanced node processes have been largely determined - prices for N3 and N5 may increase by 3-6%, and prices for CoWoS advanced packaging may increase by 8-10%.

For older node processes, TSMC is unlikely to reduce prices across the board, but may selectively lower prices for certain N6/N7 nodes and 8-inch (200mm) wafer orders to help improve utilization.

5. Why is there so much confidence in the gross margin for 2025?

JP Morgan's gross margin guidance for TSMC in 2025 (58%) is significantly higher than the market consensus (around 54%).

The report explains that confidence in TSMC comes from several factors: as most customers migrate to N3E, TSMC's yield will significantly improve; mid-single-digit price increases (covering over 50% of revenue) will bring about over 100 basis points of gross margin growth; with inventory adjustments ending and replenishment from edge AI, it is expected that older process nodes (16nm and older) will see cyclical recovery.

The report predicts that at the peak of the upcycle, TSMC's gross margin could reach 50%-60%, expected to occur in 2026.

6. How is Intel's outsourcing progressing, and will Intel's in-house production in 2026 pose a significant risk to TSMC?

Due to soft end demand, Intel's outsourcing progress is slightly below expectations.

However, the report predicts that with the launch of Lunarlake and Arrowlake processors, the outsourcing business will improve. The decline in Intel's competitiveness in the PC CPU market is not a concern for TSMC, as all other PC CPUs are manufactured by TSMC.

Furthermore, the report anticipates that Intel's in-house production may not start until the end of 2026, by which time it will not account for a large share of demand, as AI will drive more intense market competition for PC CPUs.

7. Considering the strong demand for AI and the increasing adoption of N2, will there be a significant increase in long-term capital expenditures, and will the procurement of EUV lithography machines increase to 30 units per year?

The report predicts that due to the strong demand for N2 and continued investments in expansion in Japan, Arizona, and advanced packaging, TSMC's capital expenditures will increase to $35-36 billion in 2025 and remain in the mid-$30 billion range in the coming years The report suggests that the procurement volume of EUV lithography machines is unlikely to exceed the previous peak level (26-27 units in 2021-2022) and may reach 22-23 units by 2025