AI Alone Can’t Save the Chip Industry From a Downturn

That conundrum is already apparent at the start of the second-quarter earnings season. Taiwan Semiconductor Manufacturing, the chipmaking company more commonly known as TSMC, said Thursday that second-quarter revenue fell nearly 10% from the same period last year. That marks the company’s first revenue decline in 16 quarters—the longest streak of growth since at least 2000, which is as far back as such data compiled by S&P Global Market Intelligence goes.

It wasn’t a total surprise. Analysts had been expecting a decline, as the chip industry is still mired in a slowdown because of slumping demand for products like personal computers and smartphones.

Global chip sales for 2023 through the month of May were down 21% from the same period last year, according to data from the Semiconductor Industry Association. And a turnaround doesn’t seem to be on the near-term horizon. TSMC said it now expects its full-year 2023 revenue to decline around 10% from last year on a U.S. dollar basis, compared with the low- to mid-single-digit decline the company projected just three months ago.

TSMC is now the world’s largest semiconductor company by annual revenue. And it is a contract manufacturer that produces chips designed in-house by high-tech titans such as Apple, Amazon, Microsoft and Alphabet’s Google along with other major chip designers such as Nvidia and Advanced Micro Devices, which lack their own manufacturing capabilities.

Hence, the company’s results serve as a strong bellwether for the health of the entire sector—and the latest set cast a large shadow. The PHLX Semiconductor Index slid 3.6% Thursday, with every name on the index closing the day in the red.

The drop was particularly pronounced among makers of chip-manufacturing gear, as TSMC said its capital expenditures for the year would be at the low end of its previously forecast range of $32 billion to $36 billion, which would represent a decline of as much as 12% from the previous year.

Chip-equipment makers ASML, Applied Materials, KLA and Lam Research saw their stocks average a decline of nearly 5% on Thursday.

Chip stocks have been on a tear this year. Some of the gains have come from traders trying to get ahead of the highly cyclical industry’s eventual recovery. But a big part stems from hype over generative AI—the technology that powers chatbots such as ChatGPT and that also requires powerful computing and graphics processors.

Cloud-computing giants Microsoft, Google and Amazon are racing to build up GenAI tools and services, which is driving up demand for the necessary components. Nvidia issued a blowout revenue forecast with its latest quarterly results in May, putting the chipmaker’s stock on a trajectory that pushed the company’s market value above $1 trillion. The PHLX index had jumped 22% between Nvidia’s report and TSMC’s latest results, more than double the S&P 500’s performance in that time.

But Nvidia’s quickly rising tide doesn’t lift all boats. TSMC said Thursday that AI accounts for just 6% of its current revenue, compared with 33% for smartphones. Circumstances may remain challenging for the latter; Wall Street expects Apple’s iPhone unit sales to fall 4% in the fiscal year ending in September, which would be the first such drop in four years, according to consensus estimates from Visible Alpha.

And while TSMC expects its AI business to surge—averaging 50% annual growth over the next five years—that business also has to get through some serious production constraints. Those issues are mostly on the back end of the production process, where the chips are packaged with other components.

Brian Chin of Stifel says TSMC could quadruple the number of production starts for Nvidia’s AI chips, “and output in the short run would not change because advanced packaging capacity is the choke point.”

Even Nvidia can’t fully defy the chip industry’s gravity.

Originally appeared on: TheSpuzz