Semiconductor chip foundry Taiwan Semiconductor Manufacturing (NYSE:TSM) reports results for Q2 2006 tomorrow. Will it disappoint investors with a tepid outlook for the rest of the year, like peer Chartered Semiconductor (NASDAQ:CHRT) did last week?

What analysts say:

  • Buy, sell, or waffle? Eighteen analysts follow TSM. Eight rate it a buy, nine say "hold," and one lonely analyst says "sell."
  • Revenues. Analysts are looking for $2.49 billion, on average, which would be 35% growth year over year.
  • Earnings. Analysts expect earnings to reach $0.20 per ADR.

What management says:
The semiconductor industry is in the midst of a conversion from 90-nanometer devices to 65 nanometers, and TSM is working closely with customers who want to make the switch. Unfortunately, design costs are escalating rapidly. The cost of designing a new chip at 65 nanometers is about triple the cost of a 90-nanometer design. Compounding the problem, many chips don't need to be manufactured using the leading-edge technology. As a result, an increasing percentage of total semiconductor-industry foundry revenues will likely come from mature technologies -- and competition is driving down prices for older processing technology.

In addition, few killer applications are expected to emerge over the next five to 10 years, according to Kenneth Kin, senior vice president of worldwide marketing and sales for TSM. The best we can hope for, Kin said, are "mini killer applications" that evolve from current devices.

What management does:
Despite concerns over rising costs and competition, TSM looks like the best company in the sector to bet on. The table below shows the operating margins over the past five years for four semiconductor foundries: TSM, United Microelectronics (NYSE:UMC), Chartered, and Semiconductor Manufacturing International (NYSE:SMI). TSM leads the way every year.

Operating margins

2001

2002

2003

2004

2005

TSM

(17.5)

9

19

29.6

28.3

UMC

(33.3)

(0.3)

12.9

(11)

(15.5)

CHRT

(83)

(92.8)

(51.6)

0.7

(15.5)

SMI

N/A

(203.9)

(18.1)

9.2

(9.5)
Data provided by Capital IQ.

One Fool says:
Since it's the world's largest foundry, everyone will be waiting to hear what TSM says about demand for the rest of the year. Consumer devices are responsible for more than half of all semiconductor-chip sales, so TSM would undoubtedly feel the effect of a slowdown in consumer spending. This is especially true because some of its customers operate using what is called a "fab-light" strategy. These customers have their own manufacturing facilities, but pay TSM to manufacture a portion of their chips. If demand slows down, they would likely try to keep their own facilities operating by pulling business from TSM. This makes business for the foundries potentially more volatile than for the semiconductor industry as a whole.

Nevertheless, the numbers in the table above show that this company is extremely well-run, and should be able to handle a downturn if it materializes.

Semiconduct yourself to further Foolishness:

Chip in your thoughts on our Foolish Taiwan Semiconductor message board.

David Gardner and his Motley Fool Rule Breakers team scour the stock market's high-tech frontier in their search for the next ultimate growth stock. See David's full list of cutting-edge picks with a free 30-day trial.

Fool contributor Dan Bloom owns shares of TSM. He can be reached at [email protected]. The Fool has a disclosure policy.