One of the most important companies in the world -- Taiwan Semiconductor Manufacturing (TSM 2.84%), aka TSMC -- reported its first-quarter earnings last week. The largest manufacturer of computer chips with a growing monopoly on advanced semiconductor nodes saw stable margins to start 2023 but a decline in revenue, which caused investors to sell off shares. As of this writing, TSMC is trading down almost 10% in the past month.
TSMC's guidance for the rest of the year is not optimistic, either. What does this say about the entire semiconductor industry? Should investors be wary of these stocks right now? Let's investigate.
TSMC saw a Q1 earnings slowdown
In Q1, TSMC's revenue came in at $16.7 billion, which was the low end of its previous guidance of $16.7 billion to $17.5 billion. This was down 4.8% from the fourth quarter of 2022 and 16.1% year over year, caused by major slowdowns happening in the PC and smartphone markets compared to 2021 and 2022. Declining revenue not only hurts TSMC but also its customer base, which includes gigantic companies like Apple and Nvidia.
Investors likely took solace in the fact that TSMC's profit margins held steady at 45% this quarter. Margins this high are impressive for any company, but especially a manufacturer of physical goods like TSMC. I have doubts these high margins are sustainable, though. TSMC is investing tens of billions of dollars right now to build new factories outside of Asia in places like North America and Europe. This will lessen TSMC's dependence on its Taiwan home market, which is facing a growing threat of an invasion from neighboring China. The downside of this geographic diversification is that -- at least right now -- building factories outside of Taiwan is upwards of five times more expensive. Once these factories become operational and the costs flow through TSMC's income statement, it is likely that TSMC's profit margins will decline.
Weak automotive, booming AI
Automotive revenue was the one highlight in TSMC's Q1 earnings, up 5% quarter over quarter while its other divisions saw major revenue declines. Smartphone revenue was especially weak, with revenue down a sharp 27% quarter over quarter. However, TSMC's management is guiding for weakness in its automotive segment along with the rest of its business during the second half of 2023. Investors have been betting that demand for automobile chips will rise due to the transition to electric vehicles and self-driving cars, which generally use more semiconductors than traditional vehicles. So far, this thesis is proving to be more of a narrative than what is actually happening.
Even though semiconductor demand is projected to more than double this decade to $1 trillion in annual revenue, 2023 is shaping up to be a down year. The only saving grace may be the rising demand for artificial intelligence (AI) applications like OpenAI's ChatGPT, which is powered by advanced semiconductors. In Q2 2023 (the quarter we are currently in), TSMC is guiding for revenue to be $15.2 billion to $16 billion, which is a sequential slowdown of 6.7% from Q1. Exclude the boom in demand for AI computer chips, and I bet this would look a lot worse. Again, this is bad news not just for TSMC but other semiconductor manufacturers and major TSMC customers, which are some of the largest companies in the world.
Take the long view on TSMC
The semiconductor market is cyclical, going through boom and bust cycles. Investors in semiconductor stocks like TSMC should be ready for a 2023 bust after the boom years of 2020 to 2022. This could cause semiconductor stocks to fall over the next few quarters and produce a headwind for global economic growth.
But smart investors know that over the long term (10-plus years, in this case), demand for semiconductors is set to rise. As long as other companies want chips to power smartphones, the cloud, AI tools, and electric vehicles, there will be a growing demand for semiconductors. This will benefit companies like TSMC (and therefore their stock prices) over the long term as well.
