TSMC's Gross Margin Resilience: How Overseas Fabs Impact Profitability

Taiwan Semiconductor Manufacturing Company (TSMC) is navigating a critical balance: expanding production capacity globally while protecting one of the industry’s most impressive profitability metrics. The chipmaker has embarked on an ambitious international buildout, establishing new fabrication facilities across the United States, Japan, and Germany to capture rising demand for artificial intelligence and next-generation computing solutions.

The expansion addresses multiple strategic imperatives. Beyond meeting surging customer demand for cutting-edge semiconductor nodes, TSMC is deliberately building supply chain redundancy to mitigate geopolitical risk. However, this diversification comes with a cost—international fabs are substantially more expensive to operate than Taiwan-based facilities.

Managing Margin Pressure Through International Growth

Management has transparently communicated the financial trade-off. In the near term, TSMC anticipates gross margin compression of approximately 2%, potentially widening to 3-4% as overseas manufacturing scales up. Yet the company’s recent performance tells a compelling story of offsetting pressures.

In Q3 2025, TSMC delivered a gross margin of 59.5%, representing a 170 basis point year-over-year improvement. This remarkable resilience reflects the company’s ability to sustain profitability despite significant capital investments abroad. For the fourth quarter, management guided for gross margins between 59% and 61%—the midpoint suggesting another 100 basis point annual expansion.

TSMC’s revenue trajectory further underscores operational momentum. Third-quarter revenues surged 40.8% year-over-year to $33.1 billion, driven predominantly by AI-related demand. Consensus estimates project 2025 revenues advancing 33.7% from the prior year, with 2026 expanding an additional 20.6%.

The company is betting that automation, manufacturing scale, and government incentives will eventually narrow the cost differential between Taiwan and overseas locations. Management believes this investment will prove worthwhile as major customers increasingly seek geographically distributed suppliers capable of producing advanced nodes—particularly 2nm and A16 generation chips.

Competitive Landscape Intensifies

Intel has mobilized its own foundry ambitions, investing heavily to develop advanced manufacturing capabilities. The company is prioritizing its 18A process (representing 1.8nm logic), which Intel claims delivers superior performance and efficiency compared to traditional node comparisons. This positions Intel as a credible challenger to TSMC’s N2 process roadmap.

GlobalFoundries, meanwhile, maintains a different strategic positioning. Rather than competing at cutting-edge process nodes, GlobalFoundries is capitalizing on AI-adjacent opportunities in edge computing and embedded intelligence. The company is expanding U.S. and European capacity to appeal to customers prioritizing supply chain diversification over pure technological leadership.

Market Valuation and Investor Outlook

TSM shares have appreciated 54.1% year-to-date, outpacing the broader Computer and Technology sector’s 28.9% gain. From a valuation perspective, the stock trades at a forward P/E ratio of 25.06—a meaningful discount to the sector average of 29.03.

Consensus earnings estimates reflect robust growth expectations: 2025 earnings are projected to increase 43.9% year-over-year, with 2026 advancing 20.2%. However, recent estimate revisions have trended downward over the past month, suggesting analysts are recalibrating expectations amid macro uncertainties.

Taiwan Semiconductor carries a Zacks Rank #2 (Buy) rating, reflecting conviction in the company’s strategic positioning within the AI infrastructure buildout.

The critical question for investors becomes whether TSMC can sustain its current gross margin profile while successfully absorbing international production costs. Recent results suggest the company possesses the operational leverage and customer demand tailwinds to manage this transition, though margin pressure will likely persist through the expansion cycle.