

Chipmaker TSMC offers 'long runway of growth'

Greg Smith

The world's largest contract chipmaker, Taiwan Semiconductor Manufacturing Company (TSMC), recently posted fourth-quarter numbers that matched expectations, but management's outlook was rather gloomy. That saw the shares initially under modest pressure, before quickly recovering.

Given superior scale to other foundries, we expect TSMC to maintain its leadership in contract chip-making through the cycle.

TSMC reported consolidated revenue of $NT289.77 billion ($13.04 billion) for the fourth quarter, marking a 4.4 per cent year-on-year increase. In US dollar terms, revenue increased 2.0 per cent year on year to $9.40 billion. Wafer shipments (12-inch equivalents) amounted to 2.686 million, edging down 0.5 per cent year on year.

China represented 13 per cent of revenue and has failed to grow materially, likely due to many consumers buying low-to-mid range smartphones. QILAI SHEN

Revenue from the 7-nanometre (nm) technology continued to ramp up at a good pace and accounted for 23 per cent of wafer revenue in the quarter. Revenue from the company's most advanced technology only kicked off in the second quarter of 2018. As companies adopted the 7-nm technology, 10-nm technology declined year on year to just 6 per cent in the quarter.

In the chip industry, the smaller the number of the nanometre technology, the more power can be squeezed on to a chip while they also typically become less power intensive – boosting battery life when in mobile applications.


Looking at revenue by geography, North America continues to account for the bulk of net revenue at 69 per cent in the fourth quarter, flat compared with a year ago. China represented 13 per cent of revenue and has failed to grow materially, likely due to many consumers buying low-to-mid range smartphones, which typically have lower-end chips that can be manufactured by local foundries. All other regions (Asia Pacific, Europe, Middle East and Africa, Japan) accounted for mid-single digit percentages of net revenue each.

Hitting a soft patch

TSMC's gross profit came in at $NT138.12 billion in the fourth quarter, representing a gross margin of about 47.7 per cent. The net profit margin was down slightly from the 35.8 per cent margin a year ago. Earnings were effectively in line with expectations.

TSMC's outlook disappointed, with the company forecasting revenue of between $US7.3 billion ($10.1 billion) and $US7.4 billion for the first quarter of 2019, representing a double-digit percentage decline year on year and falling well short of the $US8 billion average analyst estimate. The gross margin forecast for the quarter of 43 per cent to 45 per cent is also on the low side, as is the operating profit margin forecast of 31 per cent to 33 per cent.

TSMC is hitting a soft patch and expects it to take a couple of quarters for the semiconductor supply chain to absorb excess inventory. Cryptocurrency mining activity has declined as prices in the area have sunk, and high-end smartphone demand is likely to be slow, in part due to seasonality of releases but also tough competition from lower priced products, especially in China.

TSMC shares have been laggards over the past year, but appear to have stabilised, with much of the current down-cycle already priced in.

Through cycles, though, TSMC has an impressive track record of generating wealth for its shareholders. We believe growing silicon content in the world around us will drive chip demand higher in the years ahead, despite some inevitable cyclicality along the way, such as we are seeing now.

High-performance-computing, artificial intelligence and other fast-growing areas provide a long runway of growth in our view. In this context, an earnings multiple of around 16 times is hardly expensive.

Greg Smith is the head of research at investment research and funds management house Fat Prophets. Interests associated with Fat Prophets declare a holding in TSMC. For a free trial of Fat Prophets' daily market commentary please click here.

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