AI Chip Cyclicality Concerns Linger Over TSM Despite Strong Earnings, Guidance

SPEAKER_1 (0:00)

For more, let's bring in our panel joining us today. Melissa Otto, head of Visible Alpha Research at S&P Global Market Intelligence, and Josh Kaplan, head of Research and Investment Strategy at Market Vector Indexes. Melissa, let's start with you this morning. I mean, TSMC just had its sixth quarter of record profit. They saw net income jump almost 70 percent year over year. Their fourth quarter revenue outlook implies almost 60 percent growth at the midpoint. What is this telling you about the durability of AI demand? And what are some of your key takeaways from the report?

Melissa Otto (0:34)

Hi. Hello. Greetings from Snowflake World. I feel like every time I do one of these spots, I'm in some unusual location.

The TSMC numbers were great. They beat expectations.

I think what the market is probably very focused on at the moment is that CapEx was maintained. And there is concern about over capacity beyond 2028 And so it's weighing on the overall sentiment of the space at the moment. And we're seeing that volatility and that sell-off coming into the overall chip space.

SPEAKER_1 (1:21)

And Josh, I'd love to get your thoughts on this too. I mean, the concerns about spending beginning to slow with the reaffirmed CapEx. Were there areas of the report that were sending off small warning flags for you? And what were your key takeaways?

Josh Kaplan (1:37)

Thanks for having me.

Just like Melissa said, the report was great. Low earnings would have guessed an amazing visibility for several years out.

I think heading into this year, I kind of had more of a bullish stance on the semiconductor manufacturing space. Looking at the Fabulous designers, the gross margins were growing and growing. If I'm ASML or I'm Taiwan Semi, it's like, hold up, I want a piece of that. And they took it. This year, Taiwan Semiconductors gross margins are on the rise. Nvidia is kind of flat and these stocks are outperforming. The problem now is that we've kind of rotated through every corner of the semiconductor industry. No more surprise bottlenecks. Who's going to outperform in an industry that's already up 500, 1000 percent over a couple of years? It kind of doesn't really matter.

It's a cyclicality of this business that people don't want to really believe still exists. It could be lower demand, oversupply, tightening credit psychology, whatever it is. In Taiwan, semiconductor, about to build more capacity. That's what's happening here. That's why the stock is down. It's happening exactly as Intel fabs are coming online. Exactly when hyperscalers are running into negative free cash flow, competitors are rushing in and money is rushing out.

SPEAKER_1 (3:00)

Melissa, I'd love to get your thoughts there on the cyclicality, because that's one of the debates right now is, is this still a cyclical space? Have we exited the cycle for a period of time because demand is stripping supply so intensely? How are you looking at that component?

Melissa Otto (3:17)

All right. So many investors who have invested in the past in the space have potentially been burned because it has historically been a very boom or bust space.

This idea that these companies, including TSMC, are going to be able to smooth out and provide some longevity and resilience in the space is up for debate.

And I think we see that. I think there is another dimension to this, and that is really around the financing aspects of it. We have just seen a lot of sentiment around rates and how rates are affecting potentially the liquidity of the space and what the sort of investment cycle may look like. And right now, consensus is expecting about $3 trillion in CapEx to be spent. And if we're in an environment where rates are gonna continue to grind higher, there is some concern that we may see that number pull back. And right now, that's what the market is pricing in. And so everyone's essentially assuming those CapEx numbers are gonna correlate to what the market is, or those CapEx numbers are ultimately what are gonna be purchased. You know, that's gonna, those assumptions are gonna dictate how many chips are gonna be bought, how many data centers are gonna be built, what the infrastructure bill that is going to be. So if that comes in below expectations, say it's $2 trillion, $2 trillion is still phenomenal, but it's not $3 trillion, which is what the market is pricing in at the moment.

SPEAKER_1 (5:03)

So Josh, who's most vulnerable if we do start to see some of this capital spending eventually slow down, is it the equipment suppliers that are selling the tools, or is it the manufacturers that are investing billions of dollars to build the fabs?