Taiwan Semiconductor (TSM.US) released the financial report for the third quarter of 2024 on the pre-market of the US stock market in the afternoon of October 17, 2024, Beijing time. The key points are as follows:

1. Revenue: Price and volume rose together, hitting a new high. In the third quarter of 2024, Taiwan Semiconductor's revenue reached 23.5 billion US dollars, a new high, slightly exceeding the upper limit of the performance indicator range (22.4-23.2 billion US dollars). The revenue for this quarter increased by 12.9% compared to the previous quarter, with shipments impacting +6.8% and average selling price impacting +5.7%. Driven by new Apple models and AI demand, the company achieved simultaneous growth in volume and price this quarter.

2. Gross Margin and Gross Margin Rate: Powering up with 3nm technology, emerging from the low point. Taiwan Semiconductor's gross margin for the third quarter of 2024 was 57.8%, far better than the guidance range (53.5-55.5%). With the capacity improvement in 3nm technology, the company raised product prices and lowered unit costs this quarter, leading to a significant increase in gross margin, marking a recovery from the low point.

3. Wafer Technology: Strong demand for advanced processes. The company's growth this quarter was mainly driven by new Apple models and high-performance computing. The iPhone 16 series, equipped with 3nm chips, led to a 20% increase in 3nm revenue this quarter. The revenue share of 7nm and below has reached 69%, driven by strong demand for advanced processes. With the support of customers such as Apple and Nvidia, the company's revenue share in North America rose to 71% this quarter.

4. Taiwan Semiconductor's Performance Guidance: Expected revenue for the fourth quarter of 2024 is 26.1-26.9 billion US dollars (market expectation 24.9 billion US dollars) and a gross margin rate of 57-59% (market expectation 54.7%). On the revenue side, a growth of 11.1%-14.5% is anticipated, mainly driven by new Apple models and high-performance computing demand. The gross margin is expected to continue its rise due to the increasing share of 3nm technology, leading to a structural improvement in the company's gross margin.

Overall Impression from Dolphin: Taiwan Semiconductor's financial report this time is quite impressive.

Both revenue and gross margin for the company this quarter exceeded market expectations. Particularly, the gross margin has returned to around 58%, significantly higher than the market expectation (54.8%). This is mainly attributed to the boost from new Apple models and AI demand, continuous increase in 3nm production, leading to higher average product prices and gross margin for the company.

What's even more surprising compared to the financial data is the "greatly exceeding expectations" guidance from Taiwan Semiconductor. The company expects to achieve revenue of $26.1-26.9 billion in the fourth quarter of 2024 (market expectation $24.9 billion) and a gross margin of 57-59% (market expectation 54.7%). From the guidance, it seems that the company's revenue will increase by about $3 billion, and Dolphin believes that this is mainly driven by two aspects: 1) In the smartphone field, Apple's new devices will enter the peak shipping season in the fourth quarter, directly boosting chip demand. At the same time, as the entire iPhone16 series is using the 3nm process chips, it will further enhance the performance of the company's 3nm production; 2) In the high-performance computing sector, Nvidia's Blackwell and other AI chips will also bring additional volume in the fourth quarter.

Unlike ASML, which previously disrupted the industry chain, the current financial report from Taiwan Semiconductor will bring confidence to the industry. This is mainly because the semiconductor industry currently shows distinct structural features, with sectors such as smartphones and PCs slowly recovering, while the unique AI industry chain demonstrates relatively strong demand. As nearly 70% of Taiwan Semiconductor's current revenue comes from high-end processes, it directly benefits from this AI wave, while ASML is more significantly affected by the entire semiconductor industry.

Overall, Dolphin believes that Taiwan Semiconductor's recent performance is relatively secure. On one hand, the new iPhones from major customer Apple have brought substantial growth to Taiwan Semiconductor, from using the 3nm process in high-end models last year to incorporating 3nm chips across the entire iPhone16 series this time. This has already resulted in significant incremental benefits for Taiwan Semiconductor. On the other hand, due to the company's leading technological capabilities, it has taken on the majority of incremental AI chip orders from clients like Nvidia. With driving forces from both aspects, even if Apple shifts some demand from 5nm to 3nm, the company still has enough orders to fill the 5nm gap, thus maintaining a consistently increasing proportion of income from below 7nm. Taiwan Semiconductor is undoubtedly the "needle in the haystack" in this AI wave.

The detailed analysis is as follows:

1. Revenue: Volume and Price Rising Together, Setting Another Record Taiwan Semiconductor achieved revenue of $23.5 billion in the third quarter of 2024, hitting another historical high, slightly exceeding the upper limit of the performance guidance range ($22.4-23.2 billion). Revenue increased by 12.9% quarter-on-quarter this quarter, primarily driven by the demand increase from Apple's new devices and high-performance computing.

Taiwan Semiconductor's quarterly revenue has been well anticipated due to the disclosure of monthly business indicators. So how did the price and shipment volume change in Taiwan Semiconductor's revenue this quarter?

Dolphin looks at the main drivers of Taiwan Semiconductor's third-quarter revenue growth from the perspectives of volume and price:

1) Volume Perspective: In 2024Q3, Taiwan Semiconductor's wafer shipments were 3338 thousand pieces, an increase of 6.8% from the previous quarter. The continued growth in shipments is mainly driven by demand from Apple's new devices and high-performance computing. Although shipments are increasing, the company's capital expenditure has not shown a significant increase. Taiwan Semiconductor's capital expenditure this quarter was $6.4 billion, and the company's capital expenditure this quarter still remains relatively low. Combining with Taiwan Semiconductor's annual plans, Dolphin believes that the company will see a significant increase in capital expenditure in the fourth quarter.

Dimension of price: In 2024Q3, the wafer revenue of Taiwan Semiconductor (equivalent to 12-inch wafers) was $7040 per wafer, a 5.7% increase from the previous period. The average selling price of TSMC wafers has risen, mainly due to the continued increase in the proportion of 3nm in this quarter. The revenue share of processes below 7nm this quarter has increased to 69%.

Combining with the guidance provided by Taiwan Semiconductor for the next quarter, the expected revenue for the fourth quarter is $26.1-26.9 billion, a 7.7%-11.5% increase from the previous quarter, significantly better than the market expectation of $24.9 billion. The fourth quarter revenue will hit a new high again, mainly benefiting from the growth in product shipments of customers such as Apple and Nvidia.

Second, gross profit and gross margin: Powering up with 3nm, coming out of the trough.

In the third quarter of 2024, Taiwan Semiconductor achieved a gross profit of $13.59 billion, a 22.8% increase from the previous period. The substantial increase in gross profit is mainly driven by the growth in revenue and gross margin. TSMC's gross margin in 2024Q3 was 57.8%, up 4.6 percentage points from the previous period, far better than the market expectation (54.8%), mainly benefiting from the increase in 3nm shipments.

The two most concerning data points for Taiwan Semiconductor in the market are revenue and gross margin. Due to the publication of monthly business data, quarterly revenue is already largely anticipated by the market. Gross margin, on the other hand, is one of the key focuses of this quarterly earnings report. Here, Dolphin will analyze the main drivers behind the increase in gross margin this quarter:

"Gross profit = Wafer Revenue - Fixed Costs - Variable Costs"

1) Wafer revenue per wafer (equivalent to 12-inch): Taiwan Semiconductor's wafer revenue in 2024Q3 is approximately $7040 per wafer, an increase of $378 per wafer from the previous period. With the shipments of Apple smartphones and high-performance computing, the proportion of 3nm has significantly increased this quarter, driving the increase in average product price.

2) Fixed Costs (Depreciation and Amortization): The average fixed cost of Taiwan Semiconductor in 2024Q3 is about $1559 per wafer, a decrease of $75 per wafer from the previous period. While the total depreciation and amortization has increased, the rapid increase in production volume continues to reduce the unit fixed cost.

3) Variable cost (Other manufacturing expenses): In 2024Q3, the average variable cost of a single wafer from Taiwan Semiconductor is about $1410 per wafer, a decrease of $76 per wafer compared to the previous quarter. Under the influence of economies of scale, the company's unit variable cost also declined this quarter.

From the above breakdown, in 2024Q3, Taiwan Semiconductor's single wafer gross margin was $4072 per wafer, an increase of $529 compared to the previous quarter. With the dual drive of rising product prices and declining unit costs, the company's single wafer gross margin significantly increased this quarter, with unit prices increasing by $378 and unit costs decreasing by $151.

The performance of Taiwan Semiconductor's revenue was already anticipated by the market, with gross margin being the main focus. As the mass production of 3nm continues to drive up the company's average product price, it will significantly enhance the company's gross margin. Looking at the guidance for the next quarter at 57-59%, Taiwan Semiconductor's gross margin has already started to rise from this quarter and stabilize at around 58%. Currently, the share of 3nm is about 20%, and Dolphin believes that with the boost from new Apple devices and AI products next quarter, the share of 3nm is expected to further increase.

III. Wafer structure end: Strong demand for advanced processes

3.1 Wafer revenue share (by application type)

Smartphones and HPC are Taiwan Semiconductor's largest sources of revenue, with a combined share of 85%, making them the biggest sources of downstream revenue for the company.

Looking at the downstream segmentation applications, with the increase in Apple's new device stockpiling this quarter, the smartphone business share has slightly increased to 34%.

The company's high-performance computing share remains the largest item this quarter, reaching 51%. The company's revenue this quarter is mainly driven by both, with the smartphone business growing by 16.3% and high-performance computing growing by 10.7% compared to the previous quarter.

Dolphin believes that the revenue of the two major businesses will continue to grow in the fourth quarter. The smart phone business mainly benefits from the launch of the new Apple device, with the entire iPhone16 series adopting the 3nm node, fully realizing the iteration of the chip. In the high-performance computing field, AMD has also released new products with a 3nm process, and Nvidia's Blackwell will also start mass production, thereby driving up the revenue of Taiwan Semiconductor next quarter.

3.2 Wafer revenue share (by process node)

This quarter, the revenue share of 7nm and below continues to increase to 69%, with the revenue from advanced process nodes already being the core source of the company. Specifically, this quarter the company's 3nm revenue share has increased to 20%, while the revenue share of 5nm has slightly decreased to 32%.

This quarter, there was a significant increase in 3nm production volume, mainly due to the launch of the new Apple device and high-performance computing. Although Apple has iterated the entire iPhone16 series to 3nm this time, the company's 5nm production capacity remains full, mainly filled by orders from other customers. It can be seen that the current market demand for 3nm and 5nm production capacity is still strong, which has also significantly boosted the company's gross margin.

Based on the guidance provided by the company for the next quarter, the company's performance in the fourth quarter of 2024 will continue to benefit from the launch of the new Apple device and high-performance computing. Currently, AMD chips have also advanced to 3nm, and Nvidia's Blackwell will start mass production, providing a guarantee for the revenue growth of Taiwan Semiconductor.

3.3 Wafer revenue share (by region)

In terms of revenue from each region, North America remains the largest source of revenue for Taiwan Semiconductor, accounting for 71% of revenue. This is due to major clients such as Apple, Qualcomm, Nvidia, and AMD in North America, creating a strong commercial relationship between Taiwan Semiconductor and the USA. Apart from North America, China and the Asia-Pacific region are the other two major sources of revenue, accounting for 11% and 10% respectively this quarter. Revenue from North America saw a significant increase this quarter, mainly due to increased shipments to Apple, Nvidia, and other clients.

Considering the situations of various companies and industry chains, Dolphin believes that the current semiconductor market demand still exhibits structural characteristics. Although the sales situation of the new iPhone is uncertain, Apple's new devices are all equipped with 3nm chips this time, directly accelerating the company's process iteration. In addition, influenced by the demand for AI, Nvidia, AMD, and other high-performance computing clients continue to drive demand, leading to more demand for high-process chips. With the momentum from these two major areas, the company's performance in the fourth quarter is expected to reach new heights.

This article is from the WeChat official account of "Dolphin Investment Research", edited by Chen Xiaoyi at WiseFinancial.