Investment theory

Following our coverage of TSMC in May (NYSE:TSM), the stock quickly climbed toward our initial price target of $185, ahead of expectations. Based on TSMC’s industry-leading revenue growth and strong positioning in core markets, we are revising our price target price up to $210.

Key growth drivers include TSMC’s leadership in advanced technologies such as AI and high-performance computing (HPC). Its ability to make strategic acquisitions also solidified its market leadership and positioned it to continue to capture increased demand for advanced chip solutions.

The company places a strong emphasis on the latest cutting-edge solutions for the fast-growing AI and HPC markets, making it one of the biggest beneficiaries of global trends in the digital transformation space. Therefore, we reaffirm our Buy rating for TSM based on solid market leadership and robust fundamentals.

Fibonacci Levels and Bullish Signals point to $210+ potential in 2024

TSMC stock has solid upside potential at its current price of $175. The average price target for 2024, set at $210, aligns closely with the 0.786 3-point Fibonacci retracement level, indicating a potentially strong resistance point that could serve as a target for medium-term profits. The optimistic price target of $248 aligns with the 1.236 Fibonacci extension, which reflects the upper bound of potential profits if bullish momentum continues.

Conversely, the pessimistic price target of $168 aligns with the 0.382 Fibonacci level, indicating a potential support level if bearish conditions prevail. The Relative Strength Index (RSI) at 60.92 indicates moderate bullish momentumwhere the line trend shows an upward reversal. The presence of bullish divergence strengthens the likelihood of a sustained upward trend. The alignment of the RSI with a touchdown long setup around the 50-mark suggests that recent lows could serve as a solid support base for further gains.

The Volume Price Trend (VPT) is also showing a positive reversal, with the VPT line moving up to 140.80 million, surpassing its moving average of 133.49 million. This increase in volume supports growing investor confidencewhich may push prices higher. Based on this trend, the long setup will occur by a touchdown on the VPT moving average. This further supports the idea of ​​a bullish technical outlook.

Finally, taking into account the monthly seasonal pattern, technical indicators point to a 56% probability of positive returns in August, indicating a favorable environment for potential short-term profits.

Strategic $530.6M Acquisition of Innolux Factory: A Game-Changer for AI Chip Production

TSMC has acquired Innolux Corp’s Tainan flat-panel display manufacturing facility for $530.6 million. This fundamental value-creating strategic move aligns with TSMC’s response to the growing demand for AI chips by scaling its core businesses to capture (maximum) market demand. TSMC can overcome supply constraints in advanced packaging by repurposing the facility to expand its chip-on-wafer-on-substrate (CoWoS) capabilities, which has been a bottleneck amid booming demand for AI-related core technologies.

Furthermore, the investment could double CoWoS capacity by the end of 2025. The need for such expansion is rooted in the demand for AI chips, which has put unprecedented pressure on TSMC’s existing packaging capabilities. The expansion of CoWoS capacity reflects a focused strategy to capture the market growth presented by AI and High-Performance Computing (HPC) markets that require advanced packaging solutions.

Furthermore, the acquisition also reflects TSMC’s vertical integration strategy to gain control over more stages of the semiconductor manufacturing process. This move could improve margins (in the long run) by reducing TSMC’s dependence on third parties for advanced packaging. Since TSMC is an AI technology provider, the investment could yield high corporate returns as the AI ​​market could grow exponentially.

TSMC’s $30B CapEx Strategy: Fueling AI, HPC, and 5G Growth in 2024

TSMC’s 2024 CapEx plans focus on achieving long-term growth through strategic investments in advanced technologies. The company has narrowed its CapEx range to $30-$32 billion. Within that, 70-80% of CapEx is allocated to advanced process technologies. A further 10-20% of CapEx is allocated to specialty technologies and another 10% is allocated to advanced packaging, testing and mask making. This configuration reflects a sharp approach to manufacturing capacity building.

In addition, TSMC’s CapEx strategy expands manufacturing capacity and strengthens its specific technical capabilities to capitalize on the growing demand for AI, HPC and 5G applications. This approach ensures that TSMC can provide its customers with the most advanced semiconductor and packaging solutions.

Furthermore, the high correlation between high CapEx and stock value growth can be seen in TSMC’s price performance. The company’s previous investments in advanced technologies (5N and 3N) have consistently resulted in higher revenues and market share in the following years.

For example, TSMC’s CapEx strategy has seen continued investment in 3-nanometer (N3) and 5-nanometer (N5) technologies, which are now major revenue contributors (15% and 35%). This pattern may continue as current investments will generate revenue growth in line with accelerating demand for AI and HPC technologies.

As a result of the CapEx strategy, TSMC’s leading semiconductor foundry market can support its growth potential and broad customer base. Under the new Foundry 2.0, the company’s market share reached 28% in 2023 and can further increase in 2024. The definition of Foundry 2.0 includes packaging, testing, mask making and other advanced backend services that will benefit from the acquisition of the factory.

N3 Ramp-Up boosts demand, but margin pressure threatens profitability

TSMC’s Q2 2024 performance indicates strong demand for its leading N3 and N5 technologies. However, the ramp-up of these advanced technologies has introduced margin pressure that could hamper rapid growth. Q2 gross margin of 53.2% represents a modest sequential increase of 0.1%. However, this improvement is partially offset by margin dilution from the ramp-up of N3 technology.

The transition to N3 and associated costs, including the conversion from N5 to N3 tools and higher electricity prices in Taiwan, have contributed to the cost structure. Although gross margin may increase to 54.5% in Q3, the continued margin dilution from the N3 disaster poses a risk to maintaining high profitability.

The impact on margin is numerically noticeable when we consider that the advanced technology segment (7 nanometers and below) accounts for 67% of TSMC’s wafer revenues. The transition to newer nodes is crucial to maintaining technology leadership, but comes with higher costs.

In particular, the N3 technology alone could introduce significant CapExes, putting further pressure on margins. The relationship between CapExes and margins is key here. The majority of TSMC’s 2024 capital budget is focused on advanced process technologies such as N3. This high level of capital investment could limit near-term profitability with downward pressure on margins.

In addition, Taiwan’s high electricity costs add additional margin pressure. As TSMC expands its manufacturing footprint into regions with higher operating costs (EU and US), its ability to maintain margins will be challenged. Increasing process complexity, advanced technology costs and regional cost differences could result in lower-than-expected profitability even if revenue growth remains strong. This is seen in the pattern of gross margin declines below the long-term average even if N3 revenues materialize.

Takeaway meal

Strategic acquisitions and investments in advanced technologies are boosting TSMC’s growth potential. However, margin pressure from ramping up advanced technologies such as N3 remains difficult to monitor closely. Nevertheless, TSMC’s positioning in the fast-growing AI and HPC sectors continues to provide a positive outlook.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Be aware of the risks associated with these securities.