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Taiwan Semi (TSM) Misses on Q2 Earnings, Guidance Dull

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Taiwan Semiconductor Manufacturing Co. (TSM - Free Report) reported second-quarter 2017 earnings of 42 cents per ADR, which missed the Zacks Consensus Estimate by 14 cents. Further, it decreased 8.7% on a year-over-year basis and 24.3% sequentially.

Moreover, revenues decreased 3.8% year over year and 8.7% sequentially to $7.06 billion. The figure was better the Zacks Consensus Estimate of $7.03 billion. The year-over-year decline was primarily due to headwinds related supply chain inventory management, mobile product seasonality, and an unfavorable foreign exchange rate.

We note that management’s third-quarter guidance was unimpressive due to continued inventory adjustments at most of the smartphone manufacturers as well as unfavorable currency movement. However, management reiterated top-line growth guidance for 2017.

Quarter Details

North America accounted for 60% of total revenue, while revenue from Asia Pacific, China, EMEA (Europe, Middle East, and Africa) and Japan accounted for 14%, 11%, 7%, and 8% of total revenue, respectively.

By application, Communication, Computer and Consumer decreased 10%, 14%, and 7% respectively, while Industrial/Standard increased 9%.

By technology, 10-nanometer (nm) process technology contributed 1% of total wafer revenues. The combined 16/20-nm contribution was 26% of total wafer revenues.

Advanced technologies (28-nm and below) accounted for 54% of total wafer revenues. The company has increased 28-nm capacity to meet customer demand.

Further, Taiwan Semi expanded and improved 28-nm technologies from 28HPC to 28HPC+ and now to 22-nm. Management noted that 22ULP based technology offers a 15% performance gain or 35% power reduction as compared with 28HPC+. This technology is suitable for applications in Internet of Things (IoT), ISP, GPS, WiFi, RF and 5G millimeter wave. The company expects volume production to begin in 2018.

For 16-nm, the company will extend this technology into 12-nm, which will have about a 10% better performance or 25% lower power consumption as compared with a 16FFC. Moreover, 12-nm customers can use almost the same IP ecosystem of 16-nanometer to design better products, resulting in lower costs.

N7 & N7+: Key Catalysts

Management noted that the 7-nm product (including N7 and N7+ products) has gained significant traction (already 30 customers) within short span of receiving technology qualification. Taiwan Semi expects to have 13 new N7 product tape-outs in 2017. So far, N7 yield is well ahead of the company’s plan. Moreover, it continues to expect 10-nm to contribute to about 10% of wafer revenues this year.

Taiwan Semi expects to have a very fast and smooth N7 ramp-up in 2018, with its yield better than the 16-nm. Management also noted that N7+ would be the most advanced foundry process in 2018. It anticipates offering EUV in second-half 2018 on N7+ and then full insertion in first-quarter 2019.

Third Quarter Guidance Unimpressive

For third-quarter 2017, Taiwan Semi expects revenues to be in the range of $8.12–$8.22 billion. The guidance implies 15.7% sequential growth in revenues, driven by fast increase in the availability of 10-nm mobile customer products, partially offset by continuous inventory adjustments. Application wise, Computer and Consumer will grow better than Communication in the third quarter.

Taiwan Semi expects China smartphone market to start recovering with new model launches launch in third-quarter 2017. Management expects continued good momentum in industrial and automotive sectors.

Gross margin is anticipated between 48.5% and 50.5%, while operating margin to range between 37% and 39%.

Moreover, fourth-quarter 2017 is expected to be a strong quarter, as inventory corrections phases out.

2017 Guidance Reiterated

Management expects second-half 2017 revenues to grow almost 5% over second-half 2016.

For 2017, worldwide non-memory semiconductor growth rate is now projected to increase from 4% to 6%. This is primarily driven by a richer product mix in several markets, including computing, communication and automotive. Taiwan Semi also increased foundry growth forecast from 5% to 6%.

For 2017, the company still expects revenues to grow in the range of 5–10% (in U.S. dollar). Management noted that 10-nm yield is slightly ahead of schedule. Further, it expects 10-nm to contribute almost 10% of wafer revenues this year. The 10-nm ramp will impact Taiwan Semi’s second-half 2017 gross margin by about 2 to 3 percentage points.

Management noted that long-term growth guidance of 5–10% remains intact, with high performance computing (HPC) and artificial intelligence (AI) related applications. The company estimates that HPC total addressable market (TAM) is currently almost $10–$11 billion, which is anticipated to grow 10% a year going forward.

AI applications from the likes of Alphabet (GOOGL - Free Report) Google division and Apple’s (AAPL - Free Report) Neural Engine are growth drivers for Taiwan Semi in the long haul.

Zacks Rank & Key Picks

Taiwan Semi currently carries a Zacks Rank #2 (Buy). Applied Optoelectronics (AAOI - Free Report) with Zacks Rank #1 (Strong Buy) is a stock worth considering in the broader sector. You can see the complete list of today’s Zacks #1 Rank stocks here.

Long-term earnings growth rate for Applied Optoelectronics is currently pegged at 18.75%.

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