Ahead of Taiwan Semiconductor Manufacturing (NYSE: TSM) third-quarter earnings report due Thursday, Bank of America Merrill Lynch expects the chipmaker to beat revenue expectations, with the strong ramp of its 2nm process as the core driver, and has raised its price target while maintaining a Buy rating.

According to a research report dated October 12, analyst Haas Liu raised the price target on Taiwan Semiconductor Manufacturing (NYSE: TSM) shares from $590 to $620, and lifted the target for its Taiwan-listed shares from NT$3,100 to NT$3,260, while increasing earnings-per-share estimates for 2026 through 2028 by 2% to 9%.

The core rationale behind the upgrade is that the accelerated 2nm ramp is driving stronger-than-expected demand from Apple's mobile SoCs and AMD's server CPUs, alongside the migration of multiple GPU and ASIC products to 3nm, pushing third-quarter revenue above the upper end of the company's guidance range and laying the foundation for fourth-quarter sales growth.

BofA expects Taiwan Semiconductor Manufacturing (NYSE: TSM) fourth-quarter revenue to grow 10% to 15% quarter over quarter, with full-year growth potentially exceeding 40% year over year, in line with the company's prior guidance. Meanwhile, despite cost pressures from the 2nm ramp and overseas fab expansion, BofA forecasts gross margins of 67.0% and 67.8% in the third and fourth quarters, respectively, below the market's recent optimistic expectations of 67% to 69%, though overall margin resilience remains notable. The stock has gained more than 48% year to date, and BofA's latest price target still implies roughly 37% upside from current levels.

Third-Quarter Revenue Expected to Beat, With 2nm Ramp as Key Driver

According to the BofA research report, Taiwan Semiconductor Manufacturing (NYSE: TSM) third-quarter revenue is expected to grow 18% quarter over quarter in NT dollar terms, above BofA's and the market's estimates of 14% and 13%. Using an average exchange rate of NT$31.99 to the US dollar, third-quarter dollar revenue could reach $46.67 billion, exceeding the company's guidance range of $44.6 billion to $45.8 billion.

BofA attributes this expected beat primarily to the rapid volume ramp of the 2nm process. The firm estimates that 2nm's share of third-quarter revenue has jumped from 3% in the second quarter to about 11%, mainly benefiting from mobile SoC stocking ahead of Apple's new product launch cycle and strong growth in demand for AMD's Venice server CPUs. At the same time, incremental inventory stocking by Mediatek and Qualcomm for flagship smartphone SoCs provided supplementary support, though the scale was below seasonal levels due to weak Android demand.

At the 5nm and 3nm nodes, BofA expects capacity utilization to remain above 100%, driven mainly by high-performance computing and AI demand, including strong orders for accelerator products such as Nvidia's Rubin GPU, AMD's MI400, and AWS Trainium3, as well as continued growth in server CPUs and network switching chips.

Fourth-Quarter Outlook: Higher Blended Pricing to Drive Sales, Margins Below Market Expectations

BofA expects Taiwan Semiconductor Manufacturing (NYSE: TSM) fourth-quarter revenue to grow about 11% quarter over quarter, outperforming the 7% seasonal average of the past decade. The drivers mainly come from a continued shift in product mix toward advanced processes: revenue from 5nm and below is expected to rise from 71% in the third quarter to 75%, with 2nm contribution potentially reaching 18%, as its wafer pricing is more than 15% higher than 3nm.

However, BofA's fourth-quarter gross margin forecast is more conservative than the market's. The firm expects fourth-quarter gross margin of about 67.8%, below recent market expectations of 68% to 69%. Main drags include: a 25% to 30% quarter-over-quarter increase in depreciation in the second half of 2026 due to overseas fab and 2nm capacity expansion; and as 2nm's revenue contribution expands, the margin dilution from yield ramp could be more pronounced in the fourth quarter, with an estimated impact of 3 to 4 percentage points.

BofA's earnings forecasts for 2026 through 2028 are overall 5% to 15% above market consensus, mainly based on higher sales growth assumptions. BofA projects Taiwan Semiconductor Manufacturing (NYSE: TSM) earnings per share of NT$112, NT$161, and NT$203 for 2026, 2027, and 2028, respectively.

Capex Continues to Expand, Potentially Topping $83 Billion in 2027

Against a solid demand outlook, BofA expects Taiwan Semiconductor Manufacturing (NYSE: TSM) capital expenditure to reach about $63 billion in 2026, at the upper end of the company's guidance range of $60 billion to $64 billion. Spending will focus on advanced front-end manufacturing, including expanding 3nm capacity by about 55,000 to 60,000 wafers per month, ramping 2nm capacity by about 60,000 wafers per month, and installing initial A16 capacity of about 3,000 to 5,000 wafers per month.

Looking to 2027, BofA expects capex to jump further to about $83 billion, funding continued expansion of N3, N2, A16, and CoWoS-L, as well as initial production preparation for new technologies such as CoPoS and CPO. BofA estimates Taiwan Semiconductor Manufacturing (NYSE: TSM) capex will grow at a compound annual rate of about 20% from 2026 to 2028.

Notably, equipment suppliers plan to raise prices for front-end manufacturing equipment by 10% to 15% and back-end packaging equipment by 5% to 10% starting in 2027, which could add about 10% to Taiwan Semiconductor Manufacturing (NYSE: TSM) capex. BofA believes that given the company's strong bargaining power relative to its supply chain, these costs can be passed on to customers through foundry pricing when equipment is delivered and put into production in the second half of 2027, and expects Taiwan Semiconductor Manufacturing (NYSE: TSM) to raise advanced-process wafer prices by 5% to 10% in the first quarter of 2027.

Despite the significant capex increase, BofA estimates depreciation growth will compound at 21%, below the 32% compound annual revenue growth, supporting gross margin expansion to 68% to 69% by 2028.

Technology Leadership Advantage Continues to Widen, Competitive Position Remains Solid

BofA believes Taiwan Semiconductor Manufacturing (NYSE: TSM) is further solidifying its technology leadership in advanced processes. Using transistor density as a benchmark, the company's N3/N3E leads Intel's 3/18A by about 30%; looking ahead, BofA estimates the transistor density advantage of Taiwan Semiconductor Manufacturing (NYSE: TSM) A16/A12 nodes over Intel's 18A-P/14A will widen further to about 50% to 60%.

In back-end packaging, Taiwan Semiconductor Manufacturing (NYSE: TSM) is advancing CoWoS technology upgrades, with the 5.5x reticle size version already in mass production in 2026 with yields above 98%, and plans to push the technology to 9.5x to 14x reticle limits in 2027-2028. BofA expects CoWoS-R/L industry supply to expand at a compound annual rate of 52% to meet demand from 2026 to 2028, with Taiwan Semiconductor Manufacturing (NYSE: TSM) continuing to dominate the complex GPU and ASIC packaging market.

As for market concerns about the potential competitive threat from Elon Musk's Terafab, BofA views the risk as overestimated. The firm's analysis notes that based on a $119 billion ten-year investment plan, Terafab could build at most about 96,000 wafers per month of advanced process capacity by 2036, far below Taiwan Semiconductor Manufacturing (NYSE: TSM) scale, and faces near-term issues such as delays in Intel 18A external customer certification. BofA judges that SpaceX could instead become a key anchor customer for Taiwan Semiconductor Manufacturing (NYSE: TSM), consuming about 20% of the company's advanced process capacity in 2029.

BofA maintains its Buy rating on Taiwan Semiconductor Manufacturing (NYSE: TSM), with the price target based on 20 times 2027 estimated earnings. Haas Liu noted that the stock currently trades at about 16 times 2027 estimated earnings, in the middle of its historical valuation range of 11 to 21 times, and that current valuation is "not demanding" given the company's leadership in advanced processes.

BofA analysis shows that Taiwan Semiconductor Manufacturing (NYSE: TSM) major customers currently trade at a premium of about 45% to the company, above the long-term average premium of 22%; HPC customers carry an even higher premium of 100% to 150%, far exceeding the historical average of 53%. BofA believes that the stock's gains over the past two years were mainly driven by earnings upgrades, with limited valuation multiple expansion, and that as technology leadership further strengthens, there is room for a re-rating to at least 20 times NTM earnings.