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How TSMC Plans to Improve Its Profit Margin in 2019

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TSMC’s capacity utilization

In the previous part of the series, we saw that TSMC’s (TSM) gross margin is being impacted by a higher mix of the new 7-nm (nanometer) node and low-margin back-end processing. The gross margin is set to improve as 7-nm matures and the foundry shifts to premium packaging solutions.

Another factor pulling down TSMC’s gross margin is the lower utilization rate of the 28-nm node due to faster-than-expected migration to the 7-nm node. In the third quarter, its 28-nm process utilization rate was below 90% as 28-nm products faced an oversupply situation. It expects oversupply to be a multi-year trend.

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On the third quarter earnings call, TSMC’s chief financial officer, Lora Ho, stated that the foundry would use some of its mature nodes to make specialty technologies like CMOS (complementary metal-oxide-semiconductor) imaging sensors and power management chips to improve the utilization rate of mature nodes. Moreover, the company plans to fully depreciate the extra 28-nm capacity. She said that the above transition would improve the utilization rate of 28-nm, thereby improving the foundry’s gross margin in the second half of 2019.

Operating margin

TSMC’s profitability is largely governed by gross margin, while its operating expenses are largely governed by R&D (research and development) surrounding new manufacturing technology nodes. As it invests in the R&D of lower nodes like 7-nm+ and 5-nm, its operating expense increases.

In the third quarter, TSMC increased its revenue by 8.1% sequentially and only increased operating expense by 1.9%, which improved its operating expense ratio to 10.8% from 11.3% in the second quarter. An improved operating efficiency increased its operating margin from 36.2% to 36.6% and net margin from 31.0% to 34.2% during the same period.

Even Intel (INTC) improved its operating efficiency by focusing its R&D efforts on fast-growing segments of high-performance computing. The transition to advanced nodes is increasing TSMC’s capital expenditure. We will look into this next.

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