TSMC: Accelerating Capex to Capture AI Demand While Valuation Remains Undemanding

Core Conclusion

We maintain our Overweight rating on TSMC with a NT$2,288 price target. The stock trades at an undemanding 16x 2027e P/E. While near-term smartphone weakness presents a headline risk, resilient and structurally growing AI-related demand from HPC and networking customers is backfilling capacity. The key investment theme is the upward revision to the long-term capex and revenue trajectory, driven by the need to build out 3nm and 2nm capacity for the multi-year AI cycle, which the current valuation does not fully reflect.

What the Market May Be Underpricing

The market may be underestimating the scale and durability of the AI semiconductor demand tailwind for TSMC's most advanced nodes. Our analysis suggests TSMC's AI semiconductor revenue CAGR (2024-2029e) could reach ~60%, exceeding company guidance. Furthermore, while elevated capex is a focus, the resulting revenue growth should lead to a declining capital intensity ratio, supporting future margin expansion and cash flow.

Evidence Chain

AI Demand Offsets Smartphone Weakness, Ensuring Utilization. The impact from recent smartphone SoC order cuts (20k-30k wafers at 4nm) is non-material. Evidence from supply chain checks indicates HPC and networking customers immediately absorbed the freed capacity. Consequently, we forecast 2Q26 revenue growth of 5-10% Q/Q and a gross margin of 64%-65%. The order backlog remains long, allowing TSMC to backfill weaker consumer demand with stronger AI-related orders.

Aggressive Capacity Expansion and Conversion Underpin Long-Term Growth. TSMC is accelerating its capacity build-out to meet AI demand. We expect 3nm capacity to reach 170-180k wpm by 2026, up from ~110k in 2025. This includes the conversion of 10k-20k wpm from 4/5nm to 3nm at Fab 18 and the migration of the Japan Kumamoto P2 fab to 3nm. For 2nm, capacity is projected to build to nearly 100k wpm by end-2026. This aggressive roadmap is a direct response to sustained customer demand, including for future HBM base dies and next-gen AI processors.

Elevated Capex Drives Superior Revenue Growth and Future Margin Stability. We have raised our 2027e and 2028e capex estimates to US$65bn and US$70bn, respectively, as TSMC shortens construction and ramp timelines. This investment is necessary to capture the >US$1 trillion revenue opportunity highlighted by key customers. Crucially, this capex surge is expected to drive "very strong revenue growth in 2027 and onwards," and the resulting operating leverage should cause capital intensity to decline from peak levels, protecting long-term profitability.

Key Divergences and Risks

Geopolitical and Operational Risks. Ongoing conflicts could disrupt chemical supplies and energy, impacting fab operations and costs. The company's ability to pass through these higher costs is uncertain. New Foundry Competition. The potential entry of Tesla's "TeraFab" and the progress of Intel Foundry pose long-term competitive threats, particularly in automotive and advanced packaging. Pricing Power Versus Memory Peers. Unlike memory vendors benefiting from 80% margins, TSMC's ability to capture equivalent value from the AI boom through pricing is a key investor debate. Non-AI Demand Deterioration. A deeper or more prolonged downturn in smartphone, PC, and general consumer semiconductor demand could eventually pressure overall capacity utilization if AI demand plateaus.

Valuation and Trading Implications

Our 12-month price target of NT$2,288 is derived from a residual income model, implying a ~19x 2027e P/E. At the current ~16x 2027e P/E, the stock trades near its historical average, presenting an attractive entry point for exposure to the secular AI semiconductor theme. We expect the stock to rerate as the market gains confidence in the sustainability of the AI-driven capex and revenue upgrade cycle. The upcoming 1Q26 earnings call on April 16 should provide further clarity on 2Q26 guidance, long-term targets, and management's view on the listed risks.

Appendix: Data Summary

• Financial Forecasts: 2026e/2027e/2028e Revenue: NT$5,066bn / NT$6,344bn / NT$7,625bn. EPS: NT$94.30 / NT$116.94 / NT$139.66.
• Capex & Intensity: 2026e Capex: US$52-56bn; 2027e Capex: US$65bn (MS Est.). Capital Intensity expected to decline from 2025-26 peak.