Where Will TSMC Stock Be in 1 Year?

TSMC's (TSM 1.26%) stock popped 4% on Oct. 19 after the chipmaking giant posted its third-quarter earnings report. Its revenue declined 15% year over year to $17.28 billion but exceeded analysts' expectations by $580 million. Its earnings per ADS slipped 28% in U.S. dollar terms to $1.29, but also cleared the consensus forecast by $0.13.

TSMC's slowdown wasn't surprising, since the semiconductor market has been stuck in the mud over the past year. But over the past 12 months TSMC's stock has rallied nearly 50% in anticipation of its eventual recovery. Will those tailwinds kick in over the next 12 months and drive TSMC's stock back toward its all-time highs?

Image source: TSMC.

Focus on the sequential improvements

As the world's largest and most advanced contract chipmaker, TSMC's growth generally follows the broader semiconductor market. Over the past year, the post-pandemic slowdown of the PC market, the cooling upgrade cycle in 5G smartphones, and other macro headwinds throttled the market's demand for new chips. Western export curbs on advanced chip sales to China exacerbated that cyclical slowdown.

That's why TSMC's revenue declined year over year for three consecutive quarters. But on a sequential basis, its revenue actually rose 10% in the third quarter. It expects its revenue to rise another 11.1% sequentially in the fourth quarter. That quarter-over-quarter growth suggests the semiconductor market is finally bottoming out.

Data source: TSMC. USD terms. QOQ = Quarter-over-quarter. YOY = Year-over-year.

TSMC is still heavily dependent on the smartphone market, which accounted for 39% of its revenue during the third quarter, as well as its largest customer Apple (AAPL -0.35%). But according to IDC, global smartphone shipments could rise 5.9% in 2024 -- compared to a 1.1% decline in 2023 -- as the macro environment improves.

TSMC also produces chips for high-performance computing (HPC) clients like Nvidia (NVDA 6.18%). That market accounted for 42% of its top line -- up three percentage points from a year ago -- as the AI market expanded.

Production of newer chips will squeeze margins

TSMC's gross margin expanded sequentially in the third quarter as higher utilization rates and favorable exchange rates offset the higher costs from its production of 3nm chips. However, higher R&D expenses from the development of its latest 3nm and 2nm chips still reduced its operating margin sequentially and year over year.

Data source: TSMC.

For the fourth quarter, TSMC expects its gross margin to dip to 51.5%-53.5% as its operating margin drops to 39.5%-41.5%. But that compression isn't surprising, since it needs to ramp up its spending to start mass producing 2nm chips by 2025. 

TSMC remains ahead of Intel in the process race

One of the main threats to TSMC's market dominance is Intel (INTC -9.20%), which believes it can catch up to TSMC in the "process race" to manufacture smaller, denser, and more power-efficient chips by 2025. However, all of the latest developments suggest TSMC remains at least one full chip generation ahead of Intel.

TSMC started mass producing 3nm chips in late 2022, and generated 6% of its total revenue from those top-tier chips in the third quarter of 2023. Intel doesn't plan to launch its comparable "Intel 3" chips -- which are technically 5nm chips that provide transistor density and performance comparable to that of TSMC's 3nm node -- until 2024.

TSMC generated 37% of its revenue from its 5nm chips and another 16% from its 7nm chips during the third quarter. The remaining 41% came from its older and larger nodes.

Where will TSMC's stock be in a year?

TSMC's fourth-quarter guidance implies its revenue will dip about 9% in USD terms for the full year, compared to analysts' expectations for a 13% decline. Analysts are expecting its earnings per ADS to drop 25%.

But in 2024 they expect its revenue (based on TSMC's own full-year forecast) and earnings to grow 17% and 21%, respectively, as the semiconductor market warms up again. That's a bright outlook for a stock that trades at just 16 times forward earnings. Intel, which faces more headwinds than TSMC, has a forward multiple of 20.

Therefore, barring a major escalation of trade and military tensions between China and Taiwan, I believe TSMC's stock should head higher over the next 12 months. It faces some near-term challenges as it ramps up its development of 2nm chips, but it's still the "best in breed" play on the secular growth of the semiconductor sector.