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The gains continue to mount for Taiwan Semiconductor (TSM +1%), which is stepping back up toward last week's record highs today following a TrendForce report that the world's largest chip manufacturer is planning to raise the price of its 3-nanometer products. TSM manufactures several nanometer chips, with its 5nm chip accounting for the bulk of its latest quarterly wafer revenue. Simply, the smaller the chip, the more space it frees up, allowing for more transistors to be packed on the same chip, which can increase its power output.

While price hikes can garner positive responses as the action can boost revenue and margins, TSM's announcement is being particularly well-received for a few reasons.

• TSM anticipated its overall business to grow stronger beginning in Q2, accelerating to form a more robust second half of the year compared to the first. Its 3nm products were to play a meaningful role in its uplifting view. AI was the primary driver, as chip designers from NVIDIA (NVDA) to Advanced Micro (AMD) continue to jump at the opportunity to pull ahead in the AI race. While the technology accounted for only 9% of wafer revs in Q1, TSM expected revenue contribution to ramp starting next quarter.
• However, gross margins were compressing as revenue contribution from 3nm technologies increased. TSM projected a 3-4 pt hit to gross margins due to the uptick in 3nm revs, 1 pt worse than the dilution to Q1 gross margins. At the same time, to support 3nm capacity, TSM would be converting some 5nm tools, further diluting gross margins by an additional 1-2 pts during the back half of the year.
• As a result, TSM targeted gross margins of 51-53% for Q2, a 2 pt drop at the low end from the 53.1% delivered in Q1. TSM did not issue FY24 margin guidance. Instead, management reiterated its long-term target of at least 53%, excluding FX impacts. The company also discussed how it would work diligently to control internal costs.

Given this context, TSM's reportedly planned price hikes for 3nm products are being applauded by the market today. As NVDA and others boast massive leaps in revenue, supported by a seemingly inextinguishable demand for AI, investors may have questioned whether TSM was charging enough given its need to manage costs to maintain its long-term gross margin goals. TSM commented in April that it was working on pricing as demand for its chips continued to swell. For comparison purposes, NVDA's adjusted gross margins reached 78.9% in Q1 (May), up over 12 pts yr/yr and 2 pts sequentially. NVDA's impressive margins can explain why it is reportedly open to TSM raising its prices -- this would likely have little impact on NVDA's profitability while helping squeeze out some of its smaller competitors.

Bottom line, reports that TSM will hike the price of its most powerful chip for AI are spurring outsized enthusiasm today, as it could help offset projected margin dilution and push shares back toward all-time highs.