AI is still the driving force! Morgan Stanley is bullish on Taiwan Semiconductor, deeply interpreting ten key issues

According to the Zhitong Finance APP, JP Morgan has released a research report reiterating its "Overweight" rating on Taiwan Semiconductor (TSM.US), with a target price of NT$1,275. In the report, JP Morgan addresses the top ten key issues that investors have recently focused on regarding Taiwan Semiconductor.

1. How do you view the gross margin pressure from foreign exchange and U.S. expansion?

In the investor meetings over the past month, gross margin has remained the most concerning topic for investors, with persistent worries about the impact of the New Taiwan Dollar appreciation and overseas expansion. JP Morgan believes that the short-term impact of the New Taiwan Dollar appreciation on gross margin (in the second quarter and early third quarter) is significant (an 8% appreciation of the New Taiwan Dollar impacts gross margin by approximately 300 basis points), but this effect has been offset by some urgent orders received by Taiwan Semiconductor after a 90-day tariff suspension. Therefore, despite the strong appreciation of the New Taiwan Dollar, Taiwan Semiconductor's gross margin may still remain within the guidance range (57-59%). In the long term, as advanced wafer pricing may continue to rise, Taiwan Semiconductor can still maintain its gross margin at a high level within the 50% range.

2. What is the pricing trend for 2026? Will continuous price increases become the norm?

As JP Morgan previously pointed out, Taiwan Semiconductor may raise prices for advanced process nodes again in 2025. Initially, JP Morgan expected prices for N3, N4, and N5 to increase by 3-5%, but now the firm believes the price increase may be closer to 6-10% (in U.S. dollars) to offset the impact of the recent appreciation of the New Taiwan Dollar. Additionally, customers specifying production at overseas factories may face price increases of over 10% to compensate for additional costs. However, most investors view such price increases as incidental and do not believe they will become the norm in the coming years.

3. How confident are you in Taiwan Semiconductor's guidance of a 20% compound annual growth rate for revenue from 2024 to 2029?

JP Morgan has found that some investors are skeptical about Taiwan Semiconductor's long-term growth guidance (approximately 20% compound annual growth rate from 2024 to 2029) due to concerns about sustained growth in both artificial intelligence (AI) and non-AI sectors. However, Taiwan Semiconductor has successfully delivered on its long-term guidance over the past 15 years. JP Morgan believes that insufficient recognition of the long-term average selling price (ASP) growth potential, as well as the ongoing divergence in the value growth of most devices and unit growth, may be the main reasons for investors' caution.

4. What is the capacity and demand curve for the N2 process? Is the price of N2 wafers too high?

Recently, there have been concerns that Taiwan Semiconductor has slowed down its N2 construction plans for 2026 due to high wafer prices. However, JP Morgan has not seen any signs of this and expects the capacity ramp-up for the N2 process to be faster than that of N3 or N5. AMD, Apple, MediaTek, Qualcomm, and Intel may begin producing N2 wafers at Taiwan Semiconductor, with Apple remaining a major source of demand by 2026. JP Morgan expects the price of N2 wafers to be approximately 20%-25% higher than that of N3E, with mobile version N2 prices around $26,000 to $27,000, and high-performance computing versions potentially being more expensive.

5. What is the expected capital expenditure for Taiwan Semiconductor in 2026? When will high numerical aperture EUV begin to be used? JP Morgan expects TSMC's capital expenditure in 2025 to be around $40 billion, and around $45 billion in 2026. If TSMC signs a large-scale N2 capacity agreement with Intel, there will be further upside potential for the company's capital expenditure.

In terms of high numerical aperture EUV applications, JP Morgan remains cautious. The bank expects TSMC will not use high numerical aperture EUV in the A16 process, while the A14 process may continue to use low numerical aperture EUV and dual-mode, with some A14 processes potentially adopting high numerical aperture EUV (for technology maturity testing, etc.). The A10 process node may only start to adopt high numerical aperture EUV in large volumes around 2029-2030.

6. What impact do the U.S. EDA restrictions on China have?

JP Morgan believes that the recent U.S. EDA restrictions targeting Chinese customers may have long-term negative effects on TSMC's leading Chinese customers, but consumer clients may eventually obtain licenses or collaborate with TSMC through design service providers. N4 and N3 products may not be significantly affected, but N2-based products may face obstacles. Additionally, the supply chain seems more optimistic that NVIDIA will eventually be allowed to ship some GPUs (such as the GB202 downgraded version) to China, with initial demand for such products expected to be strong, thereby supporting N4 capacity utilization.

7. Will the CoWoS capacity expansion in 2026 be sustainable? Is supply balanced?

Compared to industry insiders, JP Morgan holds a more cautious view on the CoWoS capacity expansion plans for 2026 and continues to expect TSMC's capacity to grow from 71,000 wafers per month (wfpm) at the end of 2025 to 86,000 wfpm at the end of 2026, with the pace of expansion slowing in 2026. Demand for CoWoS related to AI in 2026 is expected to remain roughly balanced. JP Morgan believes that as companies like NVIDIA, AMD, and Qualcomm migrate in 2026, CoWoS-L may become the main capacity.

8. What are TSMC's capacity plans for N4 and N7? Will we see more conversions?

JP Morgan expects TSMC to begin converting more N5/N4 capacity to N3 capacity by the end of 2025, as demand for AI accelerators continues to shift towards N3 (targeting NVIDIA, AMD, and ASIC suppliers). The N5/N4 series is not expected to face the same overcapacity challenges as N7, as capacity construction appears to be more gradual, and peak capacity is far below that of N7. The underutilization of N7 capacity still exists, currently at 70%, with no significant signs of improvement in the second half of 2025. However, JP Morgan does not see any signs of N7/N6 capacity conversion, as TSMC's future products (WiFi7, RF transceivers, SSD controllers, etc.) will begin to ramp up capacity in the next two years and may fill the N7 overcapacity.

9. Will CoWoS orders be cut, and does this mean AI demand has peaked?

Some investors expect the AI spending cycle to peak, but JP Morgan holds a different view. JP Morgan believes that the demand trend for AI remains strong, driving AI stocks and TSMC higher in the second half of the year Given that Taiwan Semiconductor is no longer a bottleneck for artificial intelligence computing, JP Morgan does not rule out a slight adjustment to its CoWoS forecast for the second half of 2025. NVIDIA's CoWoS shipments in 2026 are expected to grow healthily, and demand for artificial intelligence will continue to grow strongly, as the demand for artificial intelligence computing may far exceed supply.

10. How will Taiwan Semiconductor handle its growing cash reserves?

Considering that Taiwan Semiconductor's cash flow has been rapidly increasing (reaching $30 billion in 2024), and its cash balance is approaching 10% of its market value, investors have been asking whether it is possible for Taiwan Semiconductor to issue a special dividend or conduct systematic buybacks. JP Morgan expects that there will not be a one-time dividend or buyback, and the main channel for Taiwan Semiconductor to return cash to shareholders will be through regular quarterly dividends. As capital intensity may have peaked, coupled with strong future cash flow growth, Taiwan Semiconductor's cash dividends are expected to grow rapidly in the coming years. JP Morgan believes that the dividend per share may double in the coming years while still supporting the capital expenditures needed for revenue growth of about 20%.

Overall, JP Morgan expects Taiwan Semiconductor's stock to continue its recent strong performance, as the demand trend for artificial intelligence becomes clearer, the growth prospects for 2026 have good visibility, advanced process prices will rise, and concerns about gross margins due to foreign exchange factors and rising costs are beginning to fade