SMIC delivered an impressive set of results for 3Q21, benefitting from the semiconductor crunch that drove up both demand and prices throughout the year. Looking ahead, we believe that China’s plans to develop its semiconductor capabilities and the possible lifting of sanctions could spur a re-rating in its share price.
Tan De Jun | Published on 15 Dec 2021
• SMIC’s revenue surged by more than 30% to a record high of USD 1,415 million, mainly due to an increase in wafer shipments and average selling price.
• Citing strong demand, the company raised its 2021 full year revenue growth target for the second time this year to 39% year-over-year, up from the previous target of 30%.
• To meet the burgeoning demand for chips from domestic companies, SMIC is planning to launch three new fabs, which should increase its production capacity by more than 25% by 2024.
• Despite being on the Entity List, export licenses to SMIC had an approval rate of 91%, which shows that the company is not significantly affected by the sanctions.
• Our target price for SMIC is HKD 37, which represents an upside potential of close to 85%.
Even in the face of adversity arising from US sanctions and the regulatory crackdown on the broader tech sector, SMIC (HKEX:981) has managed to perform well this year. In the recently announced 3Q21 financial results, SMIC saw its revenue surge by more than 30% year-over-year to a record high of approximately USD 1.4 billion (Figure 1).
Figure 1: SMIC continues to deliver strong revenue growth
The company’s remarkable performance last quarter and throughout the year was mainly due to an increase in wafer shipments and average selling price. As mentioned in our previous update, the global semiconductor industry is currently in the midst of a shortage, with lead times rising to roughly 22 weeks as of end-October, nearly double the average of 12 weeks before the pandemic began.
Across the board, chips manufactured using mature nodes (where shortages are the most severe at the moment) saw the largest increase in prices, roughly 25-40% between 2020 and 3Q21 according to Counterpoint Research. As a result, SMIC, which derives more than 80% of its sales from mature nodes, enjoyed a huge boost in revenue.
Besides the price hikes, steady capacity expansion has also enabled the company to churn out more chips than before, contributing to the strong revenue growth. From the beginning of the year to 3Q21, SMIC increased its monthly capacity by roughly 14% to an average of 593,875 eight inch equivalent wafers per month (Figure 2).
Figure 2: Capacity expansion enabled SMIC to increase its output
Citing strong demand, the company has raised its 2021 full year revenue growth target for the second time this year to 39% year-over-year, up from the previous target of 30% it announced during the middle of the year.
Ramping up capacity to meet the burgeoning demand for chips
Aside from the pandemic-driven surge in demand for semiconductors, Chinese chipmakers also face a burgeoning demand for locally made chips as Beijing continues its quest to achieve self-sufficiency.
Over the years, US sanctions on Huawei and ZTE have shown that it is not safe for Chinese companies to rely solely on foreign imports, especially for critical components like semiconductors as they can be cut off at any time. Therefore, it is imperative for China to develop its own capabilities and supply chain to minimise any future disruptions.
To meet the rapidly growing demand for chips and the country’s goal of becoming self-sufficient, SMIC is planning to embark on a large-scale expansion plan that would bring its capacity up to a total of 733,875 eight inch equivalent wafers per month by 2024, an increase of close to 25% from today (Figure 2).
The additional capacity is expected to come from the continued expansion of its existing fabs, as well as from two brand new fabs located in Shenzhen and Beijing, which are expected to be ready by 2022 and 2024 respectively. In September, the company also announced that it has entered into a joint venture with the Shanghai Municipal People’s Government to build a USD 9 billion fab in the city’s free trade zone.
All three new fabs will focus on the production of chips using mature processes (28nm and above) that are in heavy demand across the world. Many industry players believe that the 28nm node will be long-lived, as it is used in numerous applications, such as OLED drivers and connectivity chips.
Looking forward, the demand for chips produced using the 28nm node is expected to be driven by the proliferation in Internet of Things (IoT) devices, especially among industrial applications and consumer electronics.
Positive news regarding sanctions a sign that SMIC is not significantly affected
In more good news, SMIC, despite being placed on the US Entity List since December 2020, was reportedly still able to make purchases from its US-based suppliers.
Companies on the Entity list are subject to US export restrictions. US companies that wish to do business with those on the Entity List are required to apply for an export license, which are received on a presumption of denial basis.
However, according to information provided by the US Department of Commerce, out of a total of 206 SMIC export license applications received from suppliers between November 2020 and April this year, 188 of them were approved, representing an approval rate of 91%. In total, these licenses are worth a whopping USD 42 billion in sales to SMIC.
Suppliers of Huawei, another Chinese tech company on the Entity List, fared slightly worse, with an approval rate of 69% (Table 1).
Table 1: US suppliers which applied for export licenses to SMIC had an approval rate of 91%
|Number of Approvals||188||113|
|Total License Value||USD 42 billion||USD 61 billion|
|Source: SCMP, JDSUPRA, US Department of CommerceFor the period between Nov 2020 and Apr 2021|
These approvals demonstrate just how deeply both economies are intertwined, and the challenges both sides could face should they be forced to decouple completely. More importantly, the approvals also show that being on the Entity List is not the end for SMIC, and the company is still able to purchase most of the equipment that they need.
With that said, we think that investors’ worries over the sanctions may be overblown, and in reality SMIC is not significantly affected by them.
To add on, although the relationship between US and China might not be the most ideal at the moment, there is a chance that it could improve in the future. In the event that things do take a turn for the better, there is a possibility that the US will reassess its foreign policy towards China, which may lead to a re-rating in SMIC’s share price.
Undemanding valuations, huge upside potential
Since our last update in April, SMIC’s share price has fallen alongside the broader tech sector, likely due to the poor sentiment surrounding Chinese tech names, a result of US-China tensions and the regulatory crackdown.
The company’s shares are now trading at 16.1X 2023 estimated earnings, lower than its peers such as TSMC (NYSE:TSM) and Hua Hong Semiconductor (HKEX:1347) (Table 2). At current valuations, we believe that most of the negatives are already priced in, and the stock has more upside potential than downside risk.
Table 2: SMIC is trading at lower valuations vs most of its peers.
|Company||2023 Forward PE Ratio|
|Hua Hong Semiconductor||27.00X|
|Source: Bloomberg Finance L.P., iFAST Compilations|
Based on a fair PE ratio of 30X, we arrive at a target price of HKD 37 for SMIC (HKEX:981). This translates to an upside potential of approximately 85%, based on its last traded price of HKD 20 as of 14 Dec 2021.
For the past two years, the company has consistently exceeded expectations, delivering earnings above consensus estimates. Heading into 2022, we do not expect this performance to be repeated, as the company is likely to incur higher operating expenses in the form of depreciation and start-up costs owing to its expansion plans.
However, investors can take heart in knowing that this is just the beginning of China’s semiconductor journey, and there is still plenty of potential for the industry to grow. Right at the forefront of this thriving industry is SMIC, China’s number one semiconductor company.
Rising domestic demand, supportive government policies, and capacity expansion plans are factors that could enable SMIC to deliver above average earnings growth in the long run, a key ingredient for share prices to rise further.
Table 3: Earnings growth to be driven by rising domestic demand and higher average selling prices
|Source: Bloomberg Finance L.P., iFAST Estimates|