SMIC: Can it support the hopes of the entire village?

Semiconductor Manufacturing International Corporation (0981.HK/688981.SH) released its third-quarter financial report for 2024 (ending September 2024) after the Hong Kong stock market closed on November 7, 2024, Beijing time. The key points are as follows:

1. Overall Performance: Gross margin exceeds expectations again. SMIC achieved revenue of USD 2.171 billion this quarter, a quarter-on-quarter increase of 14.2, which is in line with the guidance range (quarter-on-quarter growth of 13-15%) and meets market expectations (USD 2.172 billion). The company's gross margin this quarter is 20.5%, slightly above the upper limit of the guidance range (18-20%) and better than the market consensus expectation (18.9%). The growth in revenue and gross margin this quarter is mainly attributed to the increase in the average selling price of wafer products.

2. Detailed Analysis of Three Core Indicators: Revenue, Gross Margin, and Capacity Utilization Rate. On the revenue side, through volume and price breakdown, $SMIC(00981.HK) the revenue growth this quarter mainly came from the increase in product average prices, with a slight quarter-on-quarter increase in shipment volume. This is primarily due to a significant increase in the shipment of 12-inch wafers this quarter, structurally driving up the average product price. The company's product shipment volume increased by +0.5% quarter-on-quarter, while the average product price increased by 13.6% quarter-on-quarter.

3. Business Progress: Consumer electronics are the main source of growth. The company's consumer electronics business accounted for 43% this quarter, making it the largest source of revenue, mainly driven by increased demand for inventory replenishment from related industry chain customers. The company's revenue from the China region reached a new high, accounting for 86%. Overall, domestic consumer electronics customers are the main driving force behind the company's growth this quarter, and the company continues to benefit from the increasing demand for localization.

4. Guidance for the Next Quarter: $SMIC(688981.SH) expects a quarter-on-quarter revenue growth of 0-2% for the fourth quarter of 2024, corresponding to USD 2.17-2.21 billion, slightly better than the market consensus expectation (USD 2.13 billion); gross margin is expected to be 18-20%, in line with market expectations (18.97%).

Overall View of Dolphin: SMIC's financial report is generally good.

From the quarterly data, the company's revenue meets expectations, and the gross margin exceeds market expectations again. The performance growth mainly comes from the increase in average prices. The shipment volume increased by +0.5% quarter-on-quarter, while the average product price increased by 13.6% quarter-on-quarter. Driven by the increase in the shipment proportion of 12-inch products, the company's overall gross margin achieved a structural uplift this quarter.

From the perspective of the company's downstream shipment structure, the mobile phone business saw a slight decline quarter-on-quarter, while consumer electronics was the largest incremental item for the company this quarter. Combined with Qualcomm's disclosure of its IoT business, some products in the consumer electronics category are currently in the stage of inventory replenishment in the supply chain. The localization of chips continues to advance, with the company's revenue share in the China region further increasing to 86% this quarter.

Regarding the guidance for the next quarter, Dolphin believes it is fairly standard. Since the fourth quarter is usually not the company's peak shipping season, there is a slight increase in revenue, but gross margin is under pressure from costs such as depreciation and amortization, remaining around the 20% level.

As for the capital expenditure, which the market is particularly concerned about, the company’s capital expenditure fell to $1.179 billion this quarter, down about 40% year-on-year and quarter-on-quarter. The tightening of export restrictions by Western countries has somewhat affected the company's capital expenditure this quarter (for example, starting in September, the Dutch government increased restrictions on certain DUV products from ASML).

Inventory conditions continue to improve, and capacity utilization has returned to 90%, with the company's performance gradually improving. Although depreciation and amortization remain high, as the company's capacity utilization and output increase, related costs will continue to be diluted, further benefiting the recovery of gross margin. Overall, although the semiconductor cycle has not fully warmed up, the company's operations are gradually improving driven by domestic demand. Future attention can be paid to the company's conference call for specific information on the sustainability of the recovery in China's consumer electronics and smartphone sectors, government support for domestic AI chips, and the company's development in advanced nodes.

Although the company's performance is gradually improving, the current stock price already reflects some expectations. The company is expected to have nearly 30% growth next year, but the current market value has roughly reached a PE of 25-30 times for the expected performance in 2025. Further opening up of upside potential will still require more unexpected highlights from policies, company management, or operational aspects.

The following is Dolphin's detailed analysis of SMIC:

1. Core Indicators of SMIC: Revenue, Gross Margin, and Capacity Utilization

Core Indicator 1: Revenue

In the third quarter of 2024, SMIC achieved revenue of $2.17 billion, a quarter-on-quarter increase of 14.2%, in line with the guidance range (quarter-on-quarter growth of 13-15%). The company's shipment volume slightly increased quarter-on-quarter, while prices saw a noticeable rise.

Analyzing from the dimensions of volume and price, the main influencing factors for SMIC's revenue growth this quarter are:

1) In terms of volume, SMIC's wafer shipments (equivalent to 8-inch) reached 2,122 thousand pieces this quarter, a quarter-on-quarter growth of 0.5%;

2) Price Dimension: SMIC's revenue from single wafers (equivalent to 8-inch) this quarter is $1,023, a 13.6% increase quarter-on-quarter.

From the perspective of volume and price, the revenue this quarter showed signs of recovery, mainly due to the increase in average product prices, while the company's product shipment volume only saw slight growth.

With the increase in orders from downstream customers, the company's performance this quarter has significantly improved. The rebound in average product prices this quarter is mainly due to the increase in shipment volume of 12-inch products, which structurally pushed up the company's average product price. Additionally, the company's capital expenditure this quarter fell to $1.18 billion, a 47% decrease quarter-on-quarter. Dolphin believes this part is also affected by the intensified export restrictions from Western countries.

Outlook for Q4 2024: SMIC has provided a quarterly guidance of 0-2% revenue growth quarter-on-quarter, corresponding to $2.17-2.21 billion, slightly better than the market consensus expectation ($2.13 billion). Q4 is usually not the company's peak shipping season, so this slight increase in guidance is acceptable.

Core Indicator 2: Gross Margin

SMIC's gross margin for Q3 2024 is 20.5%, a 6.6 percentage point increase quarter-on-quarter, better than the market consensus expectation (18.9%), slightly exceeding the upper limit of the guidance range (18-20%).

To analyze the reasons for the change in SMIC's gross margin this quarter, we can break down the company's cost structure:

Single Wafer Gross Margin = Single Wafer Revenue - Single Fixed Cost - Single Variable Cost

1) Single Wafer Revenue: SMIC's revenue from single wafers (equivalent to 8-inch) this quarter is $1,023, an increase of $123 per wafer quarter-on-quarter.

2) Single Fixed Cost (Depreciation and Amortization): The single fixed cost this quarter (equivalent to 8-inch) is $324, a decrease of $9 per wafer quarter-on-quarter.

3) Single Variable Cost (Other Manufacturing Expenses): The single variable cost this quarter (equivalent to 8-inch) is $490, an increase of $48 per wafer quarter-on-quarter.

4) Single Wafer Gross Margin: SMIC's single wafer gross margin (equivalent to 8-inch) this quarter is $209, an increase of $84 per wafer quarter-on-quarter.

Through the cost breakdown, it is found that the main source of the company's gross margin growth this quarter is the increase in average product prices. Additionally, under the influence of the scale effect from the increase in shipment volume, the company's unit fixed cost (depreciation and amortization) has decreased this quarter. Although the proportion of 12-inch wafers has increased, raising the unit variable cost, the company's single wafer gross margin has shown significant growth this quarter. Dolphin believes that as the company's shipment volume increases, some cost items will continue to be diluted, thus positively impacting the company's gross margin.

Looking ahead to the fourth quarter of 2024, SMIC continues to provide a quarterly guidance of a gross margin of 18-20%, in line with market expectations (18.97%). Currently, the semiconductor industry has not fully entered a prosperous cycle and is still in a recovery phase, while the fourth quarter itself is not the company's peak shipping season. Although the company's depreciation and amortization remain relatively high, the significant increase in the company's shipment volume helps to dilute the unit costs of fixed costs and other items, thereby driving the improvement of the company's gross margin.

Core Indicator 3: Capacity Utilization Rate

The capacity utilization rate not only reflects SMIC's quarterly operational situation but also reflects the trend of prosperity in the entire wafer manufacturing industry. During relatively sluggish periods in the semiconductor sector, paying attention to the capacity utilization rate helps to grasp the supply and demand changes of the company and the industry.

In the third quarter of 2024, SMIC's capacity utilization rate was 90.4%. This quarter, the company's capacity utilization rate continued to rebound but has not yet returned to full production. Dolphin believes that although the overall market demand for smartphones, PCs, and other products remains relatively weak, some of the company's clients still have inventory replenishment needs in the supply chain. The current capacity utilization rate of the company has returned to 90%, indicating that the overall supply and demand relationship in the semiconductor industry is improving.

2. Business Perspective on SMIC

After reviewing the three core indicators, Dolphin and everyone will take a comprehensive look at SMIC's quarterly business situation:

2.1 In Various Downstream Markets

This quarter, SMIC's revenue from the smartphone business accounted for 24.9%. Although the proportion has declined, the quarterly revenue remains at a relatively high level of $500 million. Dolphin believes that some companies replenished their inventory in advance last quarter, leading to a decline in shipments to smartphone clients this quarter. The consumer electronics business's proportion continued to rise to 42.6%, making it the company's largest source of revenue, mainly benefiting from the inventory replenishment needs in the supply chain (considering the high growth of Qualcomm's IoT business).

The company has segmented its past other businesses, with the computer and tablet business accounting for 16.4%, and the industrial and automotive business accounting for a low 7.9%. The computer and tablet business has shown signs of recovery, while the industrial and automotive business remains stable.

Overall, the growth in the company's revenue this quarter is mainly driven by the consumer electronics and computer and tablet businesses.

2.2 By Wafer Size

Since the first quarter of 2022, SMIC has stopped disclosing the revenue proportions of various process nodes and only reports the revenue proportions of 8-inch and 12-inch wafers, making it impossible to see the detailed revenue changes for each node In this quarter, the revenue share of 12-inch wafers at SMIC reached a new high of 78.5%. Specifically, looking at the revenue proportions of the two sizes, the revenue from 12-inch chips increased by 21.8% quarter-on-quarter, while the revenue from 8-inch chips declined by 7%. Overall, the current semiconductor market (for consumer electronics) shows strong demand for 12-inch wafers, while the demand for 8-inch wafers is relatively weak. Driven by the shipment of 12-inch wafers, the average selling price and gross margin of the company's products have further increased.

2.3 Regional Distribution

SMIC has readjusted the regional revenue distribution criteria, changing from the previous "North America/China Mainland and Hong Kong/Europe and Asia" to the current "China Region/US Region/Eurasia Region." Due to this adjustment, there are slight differences in the data.

From the regional revenue of this quarter, the revenue from the China region reached a new high of 86.4%, making the domestic market the core source of the company's revenue. Benefiting from domestic customers' demand for consumer electronics and 12-inch wafers, the company's performance has significantly improved this quarter. The demand for localization remains an important driving force for the company.

3. Operating Data of SMIC

3.1 Operating Expenses: Government Revenue Decreased

From the perspective of operating expenses, SMIC's operating expenses this quarter were $274 million, showing a rebound, mainly due to a decrease in other operating income this quarter.

Breaking down the operating expenses for this quarter, research and development expenses were $179 million, general and administrative expenses were $136 million, and sales and marketing expenses were $10 million. The decrease in general and administrative expenses was mainly due to reduced expenses for factory setup in the third quarter. In addition, the decrease in other operating income was affected by the reduction in government funding this quarter.

3.2 Operating Indicators: Operational Situation Continues to Improve

From the perspective of operating indicators, we mainly observe the company's inventory and accounts receivable:

① SMIC's inventory this quarter was $2.877 billion, an increase of 5% quarter-on-quarter;

② SMIC's accounts receivable this quarter were $939 million, a decrease of 24%.

③ Combining the relationship between inventory & accounts receivable and revenue in the balance sheet, the inventory/revenue and accounts receivable/revenue ratios for this quarter were 132.5% and 43.2%, respectively. From the perspective of operational indicators, SMIC's inventory proportion continues to decline. The alleviation of inventory pressure helps the company's gross margin to recover.

By combining the company's inventory and capacity utilization data, we can basically see the trend of the company's operational changes. When the inventory/revenue ratio exceeded 100% at the end of 2022 and continued to rise, the company significantly lowered its capacity utilization. As downstream customer demand began to recover, inventory also started to deplete, and the company gradually increased its capacity utilization. Currently, the inventory ratio has fallen back to around 130%, and the company has raised its capacity utilization to about 90%.

3.3 EBITDA Indicator: Continuing to Rise

From the perspective of EBITDA, this quarter, Semiconductor Manufacturing International Corporation (SMIC) reported an EBITDA of USD 1.157 billion, continuing to rise.

Breaking down the indicators, SMIC's EBITDA mainly comes from the release of operating profits and depreciation and amortization. The calculated profit margin (before interest, taxes, depreciation, and amortization) for this quarter remains at 53.3%. Due to the capital-intensive nature of the manufacturing industry, a large portion of the company's profits is eroded by depreciation and amortization.