The A-share listing was a duvet. SMIC (00981), a leading wafer manufacturer, registered on the Science and Technology Innovation Board in July 2020. The market value has shrunk by 55% until now, while the market value of Hong Kong stocks has shrunk as high as 64%, and long-term investors have experienced heavy losses on their books.

The Zhitong Finance App observed that while SMIC's market value continued to shrink, the performance response was relatively delayed. In 2020-2022, the company's performance maintained a steady growth trend. The compound growth rates of revenue and net profit were 36.44% and 60.24% respectively. However, the market value of AH shares fell by more than 40% during this period. However, fundamentals began to reverse in 2023. Revenue and net profit both declined, and market capitalization bottomed out and rebounded 20%.

Stocks are a weather vane for corporate value. Although SMIC rebounded in 2023, it did not last. AH shares will still double in 2024, and the market is concerned about the company's fundamentals. According to the latest financial report, in Q1 2024, the company achieved revenue of US$1.75 billion, up 19.7% year on year and 4.3% month on month. There was no increase in revenue. Net profit for the period plummeted 76.2% and 73.2% year over month, respectively.

So, are SMIC's fundamentals still expected, and can long-term investors still hold them?

Increased revenue did not increase profit

The Zhitong Finance App learned that SMIC manufactures 8-inch wafers and 12-inch wafer products. Downstream customers include smartphones, computers and tablets, consumer electronics, internet wearables, and industrial and automotive industries. The market covers China, North America, Europe and Asia, and is the largest wafer foundry in China. Until 2022, the company maintained a double-digit giveaway. Due to macroeconomic demand and supply chain fluctuations in 2023, performance declined. Demand picked up in 2024, and Q1 revenue returned to a double-digit growth trajectory.

In Q1 2024, the company returned to double-digit growth with wafer revenue of US$1,628 billion, accounting for 93% of revenue. Among them, 8-inch wafers and 12-inch wafers contributed 24.4% and 75.6% respectively, which remained stable from month to month, with impressive growth compared to 12-inch wafers. This return to growth mainly benefited from increased demand for Internet wearables and consumer electronics. The revenue shares of the two major customer segments increased by 8.1 and 4.4 percentage points to 30.9% and 13.2%, respectively.

The SMIC market is mainly concentrated in China, and the revenue contribution in previous years was relatively stable. Q1 was 81.6%, followed by the US market, which contributed 14.9%, for a total of 95.5%. Affected by domestic supply chains and industry competition, product unit prices fluctuated greatly, and as a result, gross margin and net interest rate declined to varying degrees in terms of company profits. In Q1 2024, the company's gross profit margin was 13.7%, down 7.1 and 2.7 percentage points year-on-year, respectively.

The increase in sales costs was, on the one hand, due to the company's continued expansion, which led to a sharp increase in depreciation and amortization. The Q1 increase exceeded revenue by 12.7 percentage points. On the other hand, the increase in materials and other manufacturing costs also put pressure on gross profit. However, operating expenses were optimized year over year and month over month. Among them, R&D expenses, sales expenses, and administrative expenses all improved to varying degrees. The Q1 expense rates were 10.74%, 5.31%, and 6.65%, respectively.

Excluding non-operating expenses (depreciation and amortization), the company's EBITDA margin was 50.7%, down 14.4 and 9.5 percentage points year over month, respectively. The decline in profit margins led to a sharp drop in net cash flow from operating activities to US$470 million month-on-month, and a net investment outflow gap of US$858 million. In fact, under the company's expansion strategy, net cash gaps from operating investment were very high, US$3,643 billion, US$5,044 billion and US$2.85 billion respectively. This gap was basically covered by financing.

It is worth mentioning that at present, the company's financing capacity is still relatively stable. It mainly drives asset growth under equity financing, and the share of debt financing is manageable. As of Q1 2024, the company's cash equivalent was US$5.349 billion, plus the total cash on hand of restricted capital and financial assets reached US$15.386 billion, while short-term loans were only US$1.49 billion. In addition to the total interest-bearing debt of US$10.319 billion, including long-term loans and bonds, the net cash reached US$5,067 billion.

There are still highlights in the short term

SMIC's biggest problem at present is that its production expansion strategy, which has continued for many years, has overcapacity, and ineffective production capacity will continue to eat away at the company's profit margins due to lack of demand. The company has a problem with low capacity utilization. In Q1 2024, the company's monthly production capacity was 814,500 wafers, but the capacity utilization rate was 80.8%, between 60-80% quarterly in 2023, with an average of 75%, of which only 68.1% was in Q1.

The low capacity utilization rate is constrained by multiple factors such as weak global demand, high industry inventories, and fierce competition. Of course, the fundamental factor is the company's expansion of production, which has generated more ineffective production capacity. Looking at peers, Huahong Semiconductor is relatively cautious in expanding production, and the capacity utilization rate is very high. The overall capacity utilization rate was over 90% in Q1, of which (200mm) wafer products reached 100.3%, and the capacity utilization rates reached 107.4% and 94.3% in 2022 and 2023, respectively.

Compared to SMIC's volume, Huahong Semiconductor is much smaller. Judging from the 2024 Q1 results, 8-inch wafers and 12-inch wafers are only 56.2% and 16.6% of SMIC's, respectively. They are also concentrated in the Chinese and North American markets, and there is a big difference in size. Due to its high capacity utilization rate and small size, Huahong Semiconductor's performance was stronger under active demand. In 2020-2022, the compound revenue growth rate exceeded 50%, and fell 7.6% in 2023, all superior to SMIC. However, Q1 revenue fell 27.1% in 2024, and profits turned losses. The net interest rate went from 22.3% to a loss rate of 5.5%.

As the two leading domestic foundry participants, SMIC and Huahong Semiconductor can see that the industry is not optimistic in 2024. Looking at peers, including TSMC, Advanced Semiconductors, and Lianhua Electronics, in particular, TSMC, occupy more than 50% of the global market share and have higher pricing power under price competition. Looking at the size of the industry, the global market size in 2022 was 136 billion US dollars, which was only a unit increase. The performance in 2023 was weak. The dividends of domestic double-digit growth disappeared, and participants were divided, and competition will be more intense in 2024.

The 2024 Q2 guidelines announced by the two companies reflect to some extent pessimistic expectations for the industry's profit in the first half of the year. Among them, SMIC's revenue guidance grew by 5-7%. Compared with the sharp slowdown in Q1, gross margin was 9-11%, and profitability declined further. However, SMIC has a significant potential profit. In March of this year, it was announced that it would sell Changdian Technology's holding share for 6.636 billion yuan (12.79% of the total number of issued shares). If the transfer is successful, it will generate pre-tax revenue of about 1,245 billion yuan, or 14.5% for the full year of 2023.

Most brokerage firms are concerned about the industry's prospects, and some are not optimistic about SMIC's profit prospects. For example, the Huaxing Securities Research Report believes that the company places more emphasis on expanding production than profitability, causing returns and profit growth to drop dramatically. Among them, the company's N28 and more advanced process business is carried out by a joint venture chip factory, which means it will not be able to enjoy full profits, downgrade the rating, and raise the target price from HK$18 to HK$14.

Judging from the performance of the secondary market, SMIC and Huahong Semiconductor both have similar trend characteristics. The first day of Huahong Semiconductor's listing on the Science and Technology Innovation Board (August 2023) was also the highest price, and the market value has shrunk 47% so far. The monthly trend of the two companies has improved, but the long-term trend is still uncertain. Affected by industry fundamentals, performance continues to slow down, and long-term capital or withdrawal is unable to provide momentum for an increase in market value.

However, there are certain investment highlights in the short term. Driven by events and three weeks of Lianyang brought investors confidence in shareholding. Trends investors are concerned about inflection points, and it is not ruled out that quantitative institutional capital will enter the market. In terms of selection, in terms of market premiums, SMIC's AH shares have a premium of 178.7%, and Huahong Semiconductor has a premium of 83.5%. Judging from the valuation point of view, the PB value of the Hong Kong stock SMIC is 0.82 times, while Huahong Semiconductor is 0.6 times higher. Obviously, Huahong Semiconductor's ratio is higher.