TSMC 2Q 26-top 10 holding--Insatiable demand part 2

 TSMC Q2 RESULT SUMMARY

My thoughts

Another strong result from TSMC, with the enormous AI spend driving results. TSMC raised capex from US$54B to a midpoint of $62B, as can be seen in the chart below, which is about double the average of the previous 5 years. TSMC expect revenue growth to be substantial on the capex.

TSMC guided for a fall in GM as the effects of the dilution of the 2nm investment, as well as the impact of foreign FABs. Having said that, TSMC has a record of doing better as capacity utilisation and cost control have offset the dilutions in the past.

TSMC also indicated that non-AI demand is suffering due to the higher costs involved, but AI is more than filling the gap. As can be seen in the chart below, High-Performance Computing, mainly North American clients, is driving demand.

TSMC conceded that some judgement is required to estimate true demand a few years out and realise that clients may be too bullish. They do not want TSMC chips going into inventory. They see strong demand out to 2030 at least, although there could be an air pocket. TSMC believe we are seeing a new industry created.

On pricing, TSMC stated that they will not increase prices as the memory companies have. They will price for value and that the returns they make are targeted to sustain and fund expansion.

Manufacturing excellence continues to be a driver, with tool conversion from 5nm to 3nm occurring and likely more conversion to follow when 2nm and A14 families are produced. TSMC is largely ambivalent on whether GPU, CPU or other accelerators win; they produce all of them, which is one of the main reasons TSMC is an attractive investment.

There was some discussion about competition in foundries and in advanced packaging. TSMC stated their long-held view that their advantage lies in superior technology, manufacturing excellence and customer trust and cannot be easily replaced.

TSMC is exceptionally well managed and well placed. There is little doubt that the company is becoming more concentrated in the AI story. Like many providers of AI infrastructure and build, TSMC is seeing enormous demand. The same comments apply to ASML as well; both are instrumental in the story and will continue to play a vital part in the AI rollout. The SP’s are another matter. Both companies’ share prices currently incorporate significant growth, which at this stage looks likely to occur. I’m a holder and a modest seller of both into strength and would look to add to the positions at lower prices. Managing the positions over the next few years, to sell significant strength, continue to have a reasonable holding and have capacity to add on any significant pullbacks is the strategy for both. ASML and TSMC are my exposure to the AI build phase and are both top 10 holdings.

TSMC transcript summary

During the second quarter, we generated about TWD 783 billion in cash from operations, spent TWD 496 billion in CapEx and distributed TWD 156 billion for third quarter 2025 cash dividend.

Compared to the first quarter, our second quarter gross margin increased by 150 basis points sequentially to 67.7%, slightly ahead of our guidance, primarily due to cost improvement efforts and a slightly higher overall capacity utilization rate, partially offset by dilution from our overseas fabs.

We have just guided our third quarter gross margin to decrease by 1.7 percentage points to 66% at the midpoint, primarily as we expect the steep ramp-up of our 2-nanometer technology to dilute our gross margin by about 3 to 4 percentage points.

First, we expect the steep ramp-up of our 2-nanometer to dilute our gross margin by about 3 to 4 percentage points in the second half of the year. Furthermore, as the scale of our overseas expansion grows, we continue to forecast the gross margin dilution from the ramp-up of overseas fabs in the next several years to be 2% to 3% in the early stages and widen to 3% to 4% in the latter stages.

On the other hand, demand for our leading-edge technologies is very strong. In addition, we continue to leverage our manufacturing excellence to generate more wafer output and drive greater node-to-node capacity optimisation in our fab operations to support our profitability.

Given the continued strong structural demand from our customers, including the newly emerging Agentic AI market, we have decided to raise our full year 2026 capital budget to be between USD 60 billion and USD 64 billion as we continue to invest heavily to support our customers' growth.

Looking ahead, we observe consumer and price-sensitive end market segments are being challenged due to the impact of rising component prices and macroeconomic uncertainties.

Our customers and customers' customers, who are mainly the cloud service providers, continue to provide us with a very strong signal and positive outlook. Thus, our conviction in the multi-year AI megatrend remains very high. Supported by our robust technology differentiation and the broad customer base, we now expect our full year 2026 revenue growth to be slightly above 40% year-over-year in U.S. dollar terms.

Now let me talk about the acceleration of Agentic AI. The AI market continues to be very dynamic. The emergence of Agentic AI is leading to a resurgence in the role of CPUs in AI data centres, which drives more silicon demand in addition to AI accelerators. We believe this is positive for TSMC as no matter what CPU approach is taken, whether it's x86, ARM-based, or RISC-V architecture, they are almost all TSMC's customers.

Given the fundamental complexity of leading-edge technologies and the design-in and lead time involved, we also have a very good idea of their multiyear product road map and production plans. This is important because it takes more than 5 years to develop the technology and product, prepare the capacity, and ramp it up to high-volume production.

Now, with strong collaboration and support from our leading U.S. customers and the U.S. federal state and city governments, we would like to announce an additional USD 100 billion investment in Arizona.

Now let me talk about the current N3 capacity expansion. We are executing well on our global plan to add 3 additional 3-nanometer fabs, one in Taiwan, one in Arizona, and one in Japan to support the robust multiyear pipeline of demand for 3-nanometer technologies.

In addition to all the new fabs, we continue to convert 5-nanometer tools to support 3-nanometer capacity in Taiwan.

Finally, let me talk about our A14 status. As I mentioned a few minutes ago, the complexity of leading-edge technology continues to increase. The lead time to develop a new technology such as A14, building the capacity, and then ramping it up now takes 5 to 7 years. There are no shortcuts.

Our A14 technology represents the second generation of nanosheet transistors and delivers another full node stride from N2 with performance and power benefits to address the incessant need for high-performance and energy-efficient computing. A14 technology development is on track and progressing well. Pre-production will start in 2027 and volume production is scheduled for 2028.

Both A13 and A12 are scheduled for volume production in 2029. We believe A14 and its derivative technologies will propel our A14 family to be an even larger and long-lasting node for TSMC than N2. Just like 2-nanometer technology is a larger and longer-lasting node than 3-nanometer, and here further extend our technology leadership position well into the future.

QUESTION and ANSWER SESSION

Last time, we said our CapEx in the next 3 years will be significantly higher than the CapEx in the past 3 years. Now is the -- the CapEx in the next 3 years will be even more significantly higher than the past 3 years.

 

And so now with total $265 billion CapEx in Arizona, what's your current plan to bring on the capacities in Arizona in the coming few years?

So actually, let me say that, say probably, additional 4 more fabs will be built.

 

Re competition--But the most important thing, as we continue to say, is the technology, manufacturing, and customer trust. These 3 fundamentals never change. For my 30-some-year, 40-year career, it's always the most important thing. And that's always TSMC's secret recipe to win the business….It's not that today, you think this milk is better, you go to the next store, it's a 7-Eleven. You don't like it, you go to another store. No. So that's my answer

So if you're asking about the AI's CAGR, let me give you not a number, but it's stronger and stronger and stronger.

 

Now remember that I believe every customer tell me the truth, everyone. You put all the truths together, it's not the truth. So we have to make some of the judgment. You know what I mean, since you are laughing. Because all the customers are very aggressive, right? That's the CEO's job. CEO got to be aggressive.

So yes, we do a very careful judgment. May not be correct, may not be correct, but we did carefully and because this is a big money, right? This year, we say we increased the CapEx from $52 billion to $56 billion, now $60 billion to $64 billion. And you bet, that will continue to increase. It's a big money. So we do it carefully….we're checking all that to make sure that TSMC chips will not be put in inventory.