Company Reports

Our fair value estimates for Semiconductor Manufacturing International Corp. and Hua Hong Semiconductor are unchanged at HKD 10.80 and HKD 16.50, respectively, after both firms reiterated their view of a better second half fueled by a recovery in consumer electronics demand. We view SMIC as overvalued and Hua Hong as fairly valued; SMIC’s expansion is more capital-intensive than Hua Hong's, and it has more motive to cut prices to fill up usage of its upcoming plants. The return of price hikes and upticks in automotive and industrial demand are the main upside surprises to our fair value estimates.

Our fair value estimates on Semiconductor Manufacturing International, or SMIC, and Hua Hong Semiconductor are cut to HKD 10.80 from HKD 15.60 and to HKD 16.50 from HKD 18.40 per share, respectively, after both firms commit to elevated capital expenditures for 2024 amid a longer-than-expected downturn. We view SMIC as overvalued as we are more pessimistic about the long-term profitability of its hot-headed investments. In contrast, Hua Hong looks fairly valued as its new sites are cheaper than SMIC’s, and its capital intensity is not as high. The main upside surprise to our fair value estimates is both firms issuing new shares based on their higher valuations in Shanghai. SMIC shares dropped 8% and Hua Hong 11% on Wednesday.

As the second-largest foundry in China, Hua Hong Semiconductor, or Hua Hong, focuses on providing specialty products that perform narrower sets of tasks compared with the most advanced processors. These tasks range from storing small bits of data for very long periods to regulating electricity flows. Hua Hong has no intention to offer cutting-edge chips like smartphone and data center processors, owing to financial, scale, and personnel constraints. Most of Hua Hong’s offerings are commoditized as they are fabricated on process technologies that first debuted over a decade ago. Customers can obtain a perfect or very close substitute at other chipmakers barring major shortages, which limits Hua Hong’s pricing power.

We initiate coverage on Hua Hong Semiconductor with a no-moat rating, a fair value estimate of HKD 18.40 per share, and a High Morningstar Uncertainty Rating. Shares are fairly valued. Hua Hong is China’s second-largest contract semiconductor manufacturer, or foundry, after Semiconductor Manufacturing International. Hua Hong benefits from China’s initiative to create a self-sufficient supply chain and currently derives more than 75% of its sales from Chinese customers. We forecast Hua Hong to achieve 8.7% top-line CAGR from 2022 to 2027, but to achieve that, Hua Hong is spending USD 6.7 billion, or more than double our 2024 revenue forecast, on a new plant.

As the second-largest foundry in China, Hua Hong Semiconductor, or Hua Hong, focuses on providing specialty products that perform narrower sets of tasks compared with the most advanced processors. These tasks range from storing small bits of data for very long periods to regulating electricity flows. Hua Hong has no intention to offer cutting-edge chips like smartphone and data center processors, owing to financial, scale, and personnel constraints. Most of Hua Hong’s offerings are commoditized as they are fabricated on process technologies that first debuted over a decade ago. Customers can obtain a perfect or very close substitute at other chipmakers barring major shortages, which limits Hua Hong’s pricing power.