The surging wave of artificial intelligence (AI) has provided a lifeline to Taiwan Semiconductor Manufacturing Co. (TSMC), amidst the adversity plaguing the semiconductor industry. In the past quarter, an influx of AI-related orders partially counterbalanced the downturn in the consumer electronics sector. However, in the short term, the increased demand for AI has only made a limited boost to TSMC's performance.

On the afternoon of July 20, Beijing time, TSMC, the world's largest semiconductor manufacturer, announced its second-quarter results for the period ending June 30.

The financial report revealed that TSMC's revenue this quarter was 480.84 billion New Taiwan dollars, a 10% year-over-year decline (or 13.7% in U.S. dollars), marking the first quarterly profit drop in four years. Revenue has been on a downward trend for four consecutive months. The net profit for this quarter plunged 23% compared to the same period last year, from 237 billion New Taiwan dollars to 181.8 billion New Taiwan dollars. Sequentially, revenue fell by 5.5%, and net profit decreased by 12.2%.

However, considering the overall downturn in the industry, TSMC has demonstrated impressive resilience. This quarter's revenue is largely in line with earlier forecasts, and while there has been a significant drop in net profit, it still outperforms Wall Street's prediction of a 27% decrease.

As for profitability, the gross margin for this quarter was 54.1%, the operating profit margin stood at 42.0%, and the net profit margin was 37.8%, each registering a small decline from the previous quarter.

In terms of wafer processes, shipments of the 5-nanometer process accounted for 30% of total wafer revenue for this quarter. The 7-nanometer process made up 23%, and advanced processes of 7 nanometers and above represented 53% of total wafer revenue.

Can AI Rescue TSMC?

Analysts noted that the lesser-than-expected decline in TSMC's performance this quarter is mainly attributed to the windfall from artificial intelligence.

OpenAI's chatbot, ChatGPT, sparked a frenzy of AI speculation in the first half of this year. NVIDIA GPUs are virtually the only choice for training large AI models. From cloud service providers such as Microsoft and Amazon to an array of tech companies eager to step into the AI realm, almost everyone is buying NVIDIA GPUs. According to previous reports, just this year, ByteDance's orders may be approaching the total number of commercial GPUs NVIDIA sold last year in China.

TSMC is the main contract manufacturer of NVIDIA's GPUs.

This is also reflected in the earnings. This quarter, TSMC's revenue pillar, its high-performance computing (HPC) business that includes GPU foundry services, declined by 5% sequentially, which is a noticeable improvement compared to last quarter's 14% drop.

Additionally, Electronic Times reported that mainland China's AI chip design companies have been expanding their orders for TSMC's 7-nanometer chips since the first quarter of this year.

AI HPC chip suppliers in mainland China are not included in the export ban list. At least several dozen companies are continuing to invest, and two leading chip design companies have expanded their orders for TSMC's 7-nanometer chips since the first quarter of this year.

Considering TSMC's virtually unassailable position as the "shovel maker," Wall Street powerhouses like Goldman Sachs have upgraded TSMC's target price since early June, believing that the massive demand for AI chips will be a key growth engine for TSMC over the next 3-5 years.

During the earnings call, TSMC's CEO, C. C. Wei, hinted that the current demand for AI is "overflowing," and it won't be until the end of 2024 that the company can "fully address" the AI chip supply shortage. He also stated that TSMC has incorporated AI into its capital expenditure and long-term sales outlook, projecting that approximately 50% of the forecasted revenue growth comes from the AI sector.

A Bottoming Out for the Consumer Electronics Market?

As the world's largest semiconductor manufacturer, the slump in the consumer electronics market has put pressure on TSMC's performance. Although manufacturing orders for AI chips are increasing rapidly, TSMC's performance this quarter was still weighed down by the weak overall market for smartphones.

According to Samsung Electronics' earnings guidance published this month, the company's second-quarter revenue may experience the most severe decline since 2009. Several institutions predict that Samsung's semiconductor business's losses for 2023 will exceed 1 trillion Korean won, indicating that the year-long demand winter in the consumer electronics sector is not yet over.

However, according to research firm Canalys, the consumer electronics market may be about to hit rock bottom.

Canalys reports that global smartphone shipments plummeted 11% during the second quarter of this year, marking the sixth consecutive quarterly decline. But the backlog of unsold phones is decreasing. Canalys analyst Le Xuan Chiew pointed out that smartphone suppliers are striving to cut inventory of old models to make room for new ones.

Lithography machine manufacturer ASML also recently stated that orders for lithography machines have picked up in the second quarter. This could be an early sign of a warming trend in the consumer electronics market.

However, during the earnings call, TSMC's CEO C. C. Wei said that future performance will still largely depend on the macroeconomic outlook.

Looking ahead to the third quarter, TSMC's guidance is relatively conservative. The company expects revenue to be between $16.7 and $17.5 billion (519.2 - 544.2 billion New Taiwan dollars), a slight rebound from this quarter but still below market expectations. Additionally, TSMC has further lowered its annual revenue guidance to 10%, a drop from the single-digit decline previously projected.

Bloomberg Intelligence analyst Charles Shum commented, "The resistance in smartphone demand is proving larger than expected, overshadowing the robust growth of AI chip orders. Although TSMC's reported sales exceeded consensus, after adjusting for exchange rate factors, its performance is still at the midpoint of its guidance range. I think this highlights the impact of the sluggish smartphone industry on its overall performance."

Looking forward, market conditions warrant close attention, particularly signs of a rebound in smartphone demand, to assess their potential impact on the profit trajectory for the second half of the year.

The Challenge of Building Factories in the U.S.: Lack of Skilled Workers, Delayed Production Until Next Year

During the call, TSMC executives also mentioned that their overseas expansion plans faced certain challenges. The $40 billion factory in Arizona, U.S., due to a lack of skilled workers, is experiencing a slow construction process, and the 4-nanometer wafer factory's production timeline has been delayed from the end of 2024 to 2025.

In February of this year, The New York Times reported that the cost for TSMC to build a factory in the United States is ten times that of building a factory in Taiwan. Moreover, TSMC is "not accustomed" to using American workers. The report quoted a Taiwanese engineer complaining that some American workers refuse to take on tasks when assigned multiple tasks, rather than "trying to complete all the work".

TSMC Chairman Liu Deyin stated in a conference call after the release of the financial report that they are trying to dispatch skilled technical workers from Taiwan to the United States to improve this situation.