SMIC Earnings: Worst Is Over, but There Is No Cause for Celebration

We lift our fair value estimate for Semiconductor Manufacturing International Corporation 00981 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.

Third-quarter guidance is on track to meet our full-year revenue and gross margin forecasts, hence we make no change to these metrics. Management expects sales to increase by 4% to USD 1.62 billion while the gross margin is expected to fall 1.3 percentage points from the prior quarter to 19% at the midpoint. Although management projects restocking of select Chinese customers will result in higher second-half revenue than the first-half, its outlook beyond September remains unexciting as overseas customers will take another six months to normalize their inventories as they have cut orders at SMIC later than their Chinese peers. We believe this means SMIC’s profitability will remain pressured at least until early 2024, which is consistent with our belief that there will be a lack of gross margin recovery in 2024. Also, sales and profitability improvements are limited by price cuts agreed earlier in the year that are driven by the need to keep plants loaded.

In the longer term uncertainty remains unabated on two fronts. The first relates to possible restrictions on SMIC’s ability to procure deep ultraviolet lithography machines, which are essential for expanding the firm’s 28-nanometer and 40 nm capacity.