Taiwan Semiconductor Manufacturing: Record Profits Chart the Future of AI (NYSE: TSM)

The dawn of artificial intelligence (AI) in early 2023 sparked a paradigm shift in technology spending that continues to this day. These advanced algorithms require state-of-the-art semiconductors to process the mounds of data that inform AI.

One of the unsung heroes of the AI revolution is Taiwan Semiconductor Manufacturing (NYSE:TSM), commonly known as TSMC. The company's advanced processes produce the world's most advanced AI chips. One popular narrative suggests an AI bubble is forming, and investors have been looking for evidence that AI adoption continues. As such, all eyes were on TSMC when the company reported its most recent quarterly results.

The record-shattering quarter offered the clearest evidence to date that AI has room to run.

Image source: Taiwan Semiconductor Manufacturing.

Record quarterly profits

For the second quarter, TSMC generated revenue of NT$1.27 trillion (roughly $40.2 billion), up 36% year over year. The company's gross margin climbed 910 basis points to 67.7%, up from 58.6%, while its net profit margin surged 1290 basis points to 55.6%, up from 42.7% -- all thanks to TSMC's growing operating leverage. This drove diluted earnings per share (EPS) to a record NT$27.25, up 77% year over year and 23% quarter over quarter.

Demand was particularly strong across the company's leading-edge process technologies. TSMC's 3-nanometer (nm), 5nm, and 7nm wafers accounted for 30%, 33%, and 11% of revenue, respectively. Chips used in high-performance computing (HPC) provided the lion's share of revenue at 66%, while smartphone chips made up 22% of revenue.

Why is the stock falling?

TSMC is bullish about the future and has announced plans to increase its capex spending -- a move that gave investors pause. The company now plans to invest between $60 billion and $64 billion, up from its previous forecast of $52 billion to $56 billion. Management also noted that capital spending over the coming three years would be "significantly higher" than during the past three years.

While this spending is necessary to meet the growing demand, it will likely weigh on TSMC's margins in the near future. Turns out the right move isn't always the most popular.

In another development, TSMC said it will invest an additional $100 billion in its Arizona facility, bringing its total investment to $265 billion. "This is to build several or more semiconductor logical wafer fab for two-nanometer MP [mass production] technologies, as well as advanced packaging fabs to support the strong multi-year demand from our leading U.S. customers," said CEO C.C. Wei. These 2nm chips will mark the next generation of TSMC’s leading-edge semiconductors.

For the third quarter, TSMC is forecasting revenue of $44.6 billion to $45.8 billion, which would represent 37% growth at the midpoint of its guidance. Its outlook also calls for gross profit and operating profit margins of 66% and 57%, respectively. Even amid fears that demand for AI chips will slow, TSMC's robust results and strong guidance appear to contradict that view.

Moreover, given its near-monopoly in advanced semiconductors, shares are surprisingly affordable. The stock currently sells for 34 times earnings and 25 times forward earnings, an attractive price for a company that almost single-handedly underpins the AI revolution.

Danny Vena, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.