J.P. Morgan: GUC: Google CPU orders lift results, but why are gross margins under pressure as growth accelerates?

What drove the third-quarter beat?

Early orders for Google CPUs drove GUC’s third-quarter revenue to NT$18.755 billion, up 35% quarter on quarter and 118% year on year, exceeding JPMorgan’s forecast and market consensus by 18% and 13%, respectively.
Operating profit was NT$2.551 billion, 32% above JPMorgan’s forecast. Lower-than-expected expenses were an important factor: the company adjusted its employee bonus accrual policy, smoothing fluctuations in operating expenses; the bank expects this effect to continue.
Revenue growth did not translate into a concurrent rise in gross margin. Because of the product mix, third-quarter gross margin was 20.6%, down 0.96 percentage points quarter on quarter and below the bank’s previous forecast of 20.8%.

JPMorgan forecasts that GUC’s revenue from Google CPUs will rise from more than US$1 billion in 2026 to US$3.6 billion in 2027 and US$6 billion in 2028, driven by rapidly rising demand for agentic AI.
The bank’s research indicates that the next-generation CPU, based on a 3-nanometer process, could enter mass production in the first half of 2027, with an average selling price close to twice that of the current generation and a gross margin expected to be broadly flat.
Customer concentration is also a key consideration: the bank expects Google Axion CPUs to account for 60% to more than 70% of GUC’s revenue for at least the next two to three years; meanwhile, competition in ARM CPUs and Google’s efforts to diversify its foundry sources could create pressure.

JPMorgan raised its earnings-per-share forecasts for 2027 and 2028 by 19% and 55%, respectively, to NT$144.35 and NT$256.54; its corresponding full-year revenue forecasts are NT$171.934 billion and NT$272.898 billion.
Growth comes mainly from the turnkey business. The bank expects this revenue to rise from NT$56.317 billion in 2026 to NT$160.728 billion in 2027, while forecasting its gross margin at 13.4% in 2027, below the 65% margin for design services revenue (NRE).
With the change in business mix, the bank expects overall gross margin to fall from 22.0% in 2026 to 16.8% in 2027, and operating margin to decline from 13.9% to 12.7%; by 2028, it forecasts the two margins will recover to 17.5% and 14.2%, respectively.

JPMorgan believes GUC has a good chance of securing part of the back-end work for Google’s TPU v10, a project currently at the request-for-quotation stage; Google’s use of a customer-owned tooling model for AI ASICs also creates more opportunities for design service providers.
The bank also sees potential upside in Tesla AI5／AI6 business volumes, but believes the chance of winning Amazon’s AWS Graviton CPU project is limited. Most new projects have yet to be confirmed and are not expected to contribute to earnings before 2029.
JPMorgan believes the potential of new projects supports a higher valuation. It maintained its overweight rating and raised its price target from NT$5,500 to NT$9,000; the new target represents 35 times forecast 2028 earnings per share.