Taiwan Semiconductor Manufacturing Company (TSM -1.98%) is the company behind the world's most advanced semiconductors. The largest third-party chip manufacturer has been one of the biggest beneficiaries of booming artificial intelligence (AI) spending, and that doesn't seem to be slowing down anytime soon.
TSMC's September revenue release showed accelerating sales growth, with the third quarter coming in above management's guidance and analysts' expectations. Here's what's driving the revenue growth for TSMC and why it's my top AI chip stock to buy.
Image source: Taiwan Semiconductor Manufacturing.
What's behind TSMC's rapid revenue growth?
TSMC reports monthly sales figures in New Taiwan dollars (NTD) shortly after the end of each month. September sales reached NT512 billion, up 55% year over year. Total third-quarter sales reached NT1.49 trillion, up 51%. However, the New Taiwan dollar lost value relative to the U.S. dollar over the past year, inflating those growth rates. Still, at an exchange rate of 32 NTD to USD, that translates into revenue of about $46.7 billion in revenue for the quarter, up 41% from a year ago and accelerating from 34% growth in Q2.
That number tops both analysts' expectations and TSMC's own internal forecast for revenue between $44.6 billion and $45.8 billion. Management also expected gross margin to come in between 65% and 67% and operating margin between 56% and 58%. Both represent contractions from Q2 but remain close to record levels for the company. We'll have to wait until next week for TSMC to reveal the full earnings results.
NYSE: TSM
Key Data Points
There are several significant factors driving TSMC's revenue growth.
First and foremost is the robust demand for AI-related chips. As mentioned, chipmakers rely on TSMC's manufacturing technology to develop the world's most advanced chips, which has led to booming demand for the company.
Second, TSMC quickly ramped up its 2-nanometer (2nm) production process last quarter. The technology accounted for just 3% of revenue in Q2, but that should climb quickly. While that could result in some margin pressure on the business, TSMC is reportedly charging premium pricing for its newest production node, which should offset much of it. What's more, a faster ramp means tooling utilization increases faster, reducing pressure on margins.
Beyond 2nm, pricing is well above existing processes, and management reportedly increased pricing at the start of the year for most of its chips. It plans to continue raising prices every year through at least 2029, with expectations to raise prices 10% at the start of next year.
The last piece of the revenue growth formula is TSMC's massive capacity increases. TSMC has spent heavily on capital expenditure (capex) to meet the demand of AI chip designers that contract with it. That's enabled it to bring more capacity online, and it's actually accelerated its 2nm capacity build-out for 2026. It has plans to spend hundreds of billions on new facilities in Arizona, and it's also exploring building in Texas to diversify from the geopolitical risk of its Asian facilities.
Here's why it's my top AI chip stock
What makes TSMC such a compelling investment is that it's built a wide moat that's enabled it to take market share from competitors despite already dominating the third-party chip manufacturing space. It's unlikely a company like Nvidia or Apple will be able to move a significant amount of work away from TSMC to negatively impact its growth at any point in the future. Nor is it likely they'll want to in the first place.
TSMC benefits from a virtuous cycle. As the world's largest chip fabricator, it generates a large amount of revenue relative to its peers. It can use that revenue to reinvest in research and development and additional capacity. That ensures its technology remains best in class, and it has the capacity to fulfill the growing number of orders from its chip design partners.
Importantly, TSMC is relatively agnostic about who designs the chips it makes. While Nvidia rules the roost today, it might not always be the biggest designer for AI chips. Custom silicon is growing in popularity among the hyperscalers. Regardless of who designs the chips, TSMC will be the company manufacturing them.
That gives me confidence in management's long-term revenue growth outlook of 25% average annualized sales growth between 2024 and 2029. Management is well ahead of that target, and CEO C.C. Wei suggested that number will increase once again when TSMC next updates its guidance.
With Taiwan Semiconductor stock trading for just 27 times earnings, it looks like a bargain. Revenue can grow in the mid-20s for a long time, and earnings growth should significantly outpace that level thanks to price increases protected by its wide moat.
