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.

Even though restrictions on Semiconductor Manufacturing International Corp. may be here to stay, we maintain our view that the company can win customers in nascent industries by a combination of reasonable pricing, reliable supply, and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, autonomous driving, and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of the AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

Our fair value estimate on Semiconductor Manufacturing International Corporation, or SMIC, stays at HKD 15.60 per share after factoring in the latest management guidance. On top of bearish management commentary on the next 12 months, we view the stock to be overvalued as we believe procurement risks are trending higher, and the firm’s capital spending may take longer to bear fruit. The key upside risk to our fair value is Chinese equipment makers making breakthroughs faster than anticipated, which would have mitigated risks of losing access to advanced tools.

We lift our fair value estimate for Semiconductor Manufacturing International Corporation by 4% to HKD 15.60 per share after adjusting nonoperating items that resulted in higher 2023 and 2024 EPS (up 170% and 65%, respectively). Our revenue and gross margin assumptions are unchanged and the stock remains overvalued as we believe the market underestimates the capital expenditure required to capture incremental electric vehicle, industrial, and consumer electronics demand. Upside risks to our fair value estimate are unexpectedly strong government stimulus and the company’s possible share offer priced based on its A-share.

Even though restrictions on Semiconductor Manufacturing International Corp. may be here to stay, we maintain our view that the company can win customers in nascent industries by a combination of reasonable pricing, reliable supply, and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, autonomous driving, and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of the AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

We keep our fair value estimate on no-moat Semiconductor Manufacturing International Corporation, or SMIC, at HKD 15 after the company reported unsurprising March quarter results and affirmed its full-year guidance. The stock is overvalued, in our view, due to expectations that the firm can offer new shares based on its higher A-share price, 10% lower 2024 and 2025 revenue forecasts than PitchBook consensus, and overlooking the heavy capital spending required to meet incremental demand in electric vehicles and industrial applications.

We cut our fair value estimate on no-moat Semiconductor Manufacturing International to HKD 15 from HKD 21, after assuming higher capital expenditure and lower gross margins throughout our 2023-27 forecasts. Our fair value estimate corresponds to 0.8 times price/book. The stock is fairly valued, in our view, but there is a risk of overshooting if Chinese equipment suppliers were successful in developing homemade alternatives; Japan and the Netherlands enforce export restrictions (as reported recently by Reuters) to China less fervently than expected; or the firm is able to price potential share offerings based on its A-share price, which is about triple that of Hong Kong.

Even though restrictions on Semiconductor Manufacturing International Corp. may be here to stay, we maintain our view that the company can win customers in nascent industries by a combination of reasonable pricing, reliable supply, and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, autonomous driving, and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of the AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

We maintain our HKD 21 fair value estimate for Semiconductor Manufacturing International Corporation after trimming our 2022-26 revenue and operating expenses and moving some of the 2023 capital expenditure to 2022. The stock is modestly undervalued in our view, as it is trading just below book value and a slowdown in 2023 is already priced in. SMIC’s share price is depressed by potential setbacks from U.S. export controls announced in October, and lower utilization in the next three quarters due to tepid consumer electronics demand. Abating inflation in the U.S. and gestures by China to eventually exit its zero-tolerance COVID-19 policy lead us to view that downside to the stock is limited, and the stock can be pushed higher by a potential rebound in China consumer electronics demand.

We retain our fair value estimates for TSMC at TWD 990 (USD 166 per ADR), UMC at TWD 62, and SMIC at HKD 21 per share respectively after the U.S. Department of Commerce introduced new rules to restrict semiconductor-related exports to China on Oct. 7. We intend to update our forecasts for both companies once they announce financials later this month. We believe short-term uncertainties over foundry demand will increase, as China is the world’s second-largest cloud computing market, and local cloud service providers may struggle to secure chips for their expansion initiatives. The new shock may further dampen sentiment in a sector that is already ravaged by weak consumer electronics demand. However, our long-term outlook remains positive, since export licenses are still possible under the new rules, and unfulfilled demand can be met by overseas peers. Although we believe TSMC is undervalued as an outsize beneficiary in cloud services over the long term, its near-term share performance may be weaker than UMC and SMIC given its exposure in cutting-edge nodes.

We maintain our HKD 21 fair value estimate for Semiconductor Manufacturing International Corp. after adjusting our 2022 and 2023 revenue forecasts and long-term capital expenditure projections but leaving other estimates unchanged. We are moving our Morningstar Uncertainty Rating to High from Very High owing to more visibility on possible restrictions on buying equipment from U.S. suppliers. The stock is modestly undervalued, in our view, as it is trading just below book value. We believe a rebound in consumer electronics demand and more information on advanced manufacturing (14 nanometers and below) can move the stock higher.

Even though restrictions on Semiconductor Manufacturing International Corp. may be here to stay, we maintain our view that the company can win customers in nascent industries by a combination of reasonable pricing, reliable supply, and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, autonomous driving, and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of the AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

We maintain our HKD 21 fair value estimate for Semiconductor Manufacturing International Corporation after slightly bumping up 2022 gross margin assumptions but leaving our longer-term forecasts unchanged. The stock is undervalued in our view as it is trading below book value and its five-year historical average of 1.1 times book. We believe the stock can move higher once the risks of more U.S. sanctions are reduced, and a rebound in consumer electronics demand boosts sentiment.

Our fair value estimates for: United Microelectronics Corp, or UMC (TWD 52); Taiwan Semiconductor Co, or TSMC (TWD 990), and Semiconductor Manufacturing International, or SMIC (HKD 21), are unchanged amid war in Ukraine and raw material markets' volatility. We believe foundries’ inventory of raw materials and gases, and their long-term agreements with suppliers help cushion most short-term supply shocks and buy time for securing alternative sources if the conflict drags on. Today’s risk aversion serves as an entry point for TSMC, in our view.

Even though restrictions on SMIC may be here to stay, we maintain our view that SMIC can win customers in nascent industries by a combination of reasonable pricing, reliable supply and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, or AI, autonomous driving and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

We raise our fair value estimate on Semiconductor Manufacturing International, or SMIC, to HKD 21 per H-share, equating to 1.1 times 2022 price/book ratio. The positive impact from increased operating profit estimates is mostly offset by higher capital expenditure assumptions from 2022-24. The stock appears fairly valued, as there are few fresh details on new capacities and we are concerned with a potential oversupply in 2024. Even though the "unverified list" that the U.S. just announced does not affect SMIC directly, we believe it signals the U.S. has not materially softened its stance on Chinese companies.

We maintain our fair value estimate on Semiconductor Manufacturing International, or SMIC, at HKD 19.2 per H-share, equating to 1.2 times 2021 price/book ratio. The positive impact on our valuation from increasing 2022-25 revenue and operating profit estimates by 11% and 12% on average, respectively, has been canceled by higher capital expenditure assumptions from 2022-24 at USD 3.8 billion each year versus just over USD 3 billion before. The stock appears fairly valued, as the market has priced in revenue contribution from new capacities. We see additional new fab announcements to be potential upside catalysts for SMIC, while new waves of follow-up actions from the U.S. may trigger selling pressure, underpinned by the U.S.' new "Secure Equipment Act" that bars new authorization of permits from companies like Huawei.

Even though restrictions on SMIC may not end soon, we maintain our view that SMIC can win customers in nascent industries by a combination of reasonable pricing, reliable supply and wide product offering. The company’s long-term growth driver is to ride on China’s massive investments in data centers, artificial intelligence, or AI, autonomous driving and automation. This echoes the Chinese government’s pledge to deploy CNY 10 trillion in support of AI and semiconductor sectors. Most of these applications require powerful compact chips, boosting demand in advanced nodes. Assuming development in these industries does not slow, we think it would take at least 20 years for the new markets to mature, supporting SMIC’s long-term investment thesis as China’s prime foundry.

We retain our fair value estimate of HKD 19.20 on SMIC as new documents from the U.S. Congress are consistent with our base case view that SMIC will not gain access to sub-14nm equipment. The Republican Foreign Affairs Committee has publicized documents pertaining to export licenses to Huawei and SMIC. Those documents show over 90% of license applications were granted regarding SMIC with an aggregate contract value of USD 41.9 billion from Nov. 9, 2020 to April 20, 2021. Even though shares of SMIC rallied over 4% on Friday in Hong Kong, we think fundamentals of the company have not changed and investors will focus on its aggressive expansion plans and overall chip shortage after the initial excitement wanes.