In the previous article, we learned that Taiwan Semiconductor Manufacturing Company (TSM) is moving ahead of the competition by starting volume production on the 7 nm (nanometer) node by the end of 2018.
TSMC is a pure-play foundry and bears fixed overhead costs for running its fabs (fabrication facilities). Its profitability is subject to higher yields, the optimal utilization of its production capacity, and a favorable mix of technology nodes.
As we can see in the graph above, TSMC’s gross margin expanded significantly in the second quarter of 2016 as it became the sole manufacturer of Apple’s (AAPL) A-series processors, which improved its product mix and factory utilization. TSMC’s gross margin contracted from 51.5% in the second quarter of 2016 to 47.8% in the second quarter of 2018 as smartphone sales slowed, which reduced orders from Apple.
Second-quarter gross margin
In the second quarter, TSMC’s gross margin contracted to 47.8% from 50.3% in the previous quarter. Its gross margin contracted 2.5 percentage points as weak orders from smartphone and cryptocurrency customers reduced its capacity utilization. This contraction was partially offset by a favorable foreign exchange rate and a reduction in the cost of production through a favorable technology mix.
Third-quarter gross margin estimate
For the third quarter, TSMC expects its gross margin to expand by more than 1 percentage point to 49% at the midpoint of its guidance. The company expects increasing orders from smartphone clients to improve its capacity utilization. It also expects the foreign exchange rate to remain favorable and have a positive effect on its gross margin.
However, these benefits will be partially offset by the ramp-up of the 7 nm node, which could take time to achieve a mature yield. Moreover, the shift of product mix to HPC (high-performance computing) will see more products being produced on advanced nodes, thereby reducing the contribution of the mature 28 nm node, which has a low production cost.
TSMC aims to achieve a gross margin of 50% in the long term. Next, let’s look at its operating margin.