Price increases are unsustainable, and SMIC is taking on the "cyclical disaster"

On the evening of August 11th Beijing time, Longbridge HK released its 2022 Q2 financial report (as of June 2022), with the following highlights:

1. Overall performance: Both revenue and gross profit margin reached the upper limit of guidance. SMIC achieved revenue of 1.903 billion US dollars this quarter, a quarter-on-quarter increase of 3.3%, and the revenue end reached the company's expected upper limit (1-3%). The company's gross profit margin has fallen slightly this quarter to 39.4%, but it still meets the expected upper limit (37-39%), which is better than the market expectation (38.24%).

2. Detailed analysis of the three core indicators: revenue, gross profit margin and capacity utilization rate. The increase in SMIC's revenue this quarter mainly comes from the increase in shipments. Under the impact of the epidemic in Q2, the expansion of capacity provided a guarantee for the company's growth in shipments. However, the price growth of the products this quarter has stagnated, indicating that the industry as a whole has reached its peak. The decline in gross profit margin this quarter is mainly due to the increase in costs, including the increase in the company's capital expenditure, which directly leads to the growth of fixed cost items. The capacity utilization rate in Q2 declined from full load in the past to 97.4%. Due to the company's continued expansion of production this quarter, Dolphin Analyst believes that the decline in the capacity utilization rate this quarter is mainly due to the impact of the Shanghai epidemic and other factors.

3. Business progress: The weakness of the smartphone business has been weakened, and 12 inches is still the focus of the company. The proportion of the intelligent smartphone business continued to decline to a quarter, and although the performance of the smartphone market was sluggish in the first half of the year, the impact on SMIC was gradually weakening as the proportion of the smartphone business decreased. With the release of new production capacity in Q2, the proportion of SMIC's 12-inch revenue increased to nearly 70%, and it will still be the focus of the company's future development. As the impact of the "chip bill" and other events further promotes the demand for local chip manufacturing, SMIC's customers in mainland China and Hong Kong this quarter reached a historical high.

4. Q3 guidance: SMIC expects revenue to increase by 0-2% QoQ in Q3 2022 (corresponding to 1.903-1.941 billion US dollars) and gross profit margin to be 38-40%. The revenue guidance is slightly lower than market expectations (1.955 billion US dollars), while the gross profit margin guidance is better than market expectations (36.31%).

Overall view:

SMIC's overall performance this quarter is satisfactory. Both the revenue end and gross profit margin have reached the upper limit of the company's guidance, but there has been no obvious performance exceeding expectations.

Dolphin Analyst believes that the growth of SMIC's revenue this quarter mainly comes from the expansion of capacity, and there is no obvious driving effect of prices. In other words, the continuous upward price trend of SMIC's products (silicon wafers) in the past few quarters began to show signs of stagnation this quarter. With the situation of prices not increasing but product costs rising, SMIC's gross profit margin in this quarter has also begun to decline. Inventory continues to rise, and price growth begins to stagnate, both of which indicate signs of the industry peaking. Just like the industry risk warning given by the company in this financial report, "this cycle adjustment will last at least until the first half of next year."

Short-term wise, SMIC has given guidance for the next quarter. The company's Q3 revenue is expected to grow 0-2% QoQ and gross margin to be between 38-40%. Combined with the Q3 guidance given by UMC (no increase in price or shipment), Dolphin Analyst believes that SMIC's revenue growth in Q3 mainly comes from the increase in shipment volume, and the company will continue to expand its production in Q3.

Looking at the medium and long term, SMIC still has certain alpha in the industry's downward phase. As the industry enters the downward phase, the logic of price increase no longer exists. And SMIC's alpha, mainly at the level of quantity, comes from the increase in shipment volume and the expansion of production capacity. As China's semiconductor market demand accounts for more than 30% of the global demand, while the proportion of domestic chip production capacity is less than 10%. With the fermentation of events such as the "chip act," domestic semiconductor manufacturers have intensified their efforts to adjust orders to domestic manufacturers to ensure the safety of the supply chain. Therefore, benefiting from a large amount of domestic demand for substitution, SMIC will continue to expand its production capacity.

Dolphin Analyst believes that although there is downward pressure on the industry, which has a beta impact on the company and product prices, the expansion of quantity also has the potential to bring alpha gains to SMIC in the downward market.

Regarding this financial report, Dolphin Analyst pays attention to the following issues:

1. Overall performance vs. market expectations: whether SMIC's three core indicators, revenue, gross margin, and production capacity utilization, have outperformed market expectations.
2. The specific source of revenue growth: how much did volume and price contribute to the company's revenue growth this quarter? How is the company's production capacity utilization rate affected by the epidemic situation in Shanghai and other places?
3. The source of gross margin improvement: whether the company's gross margin can reach the expected level this quarter, how prices and cost changes affect it, and whether the increase in raw material prices still has an impact.
4. Business development: How is the downstream performance of SMIC, and how is the progress of domestic semiconductor customers?
5. Performance in operation: What changes have occurred in SMIC's operation this quarter? Are the inventory and accounts receivable reasonable? How about EBITDA?

The following is Dolphin Analyst's detailed analysis.

I. Core Indicators for SMIC: Revenue, Gross Margin, and Production Capacity Utilization

Core Indicator 1: Revenue

In Q2 2022, SMIC realized revenue of USD 1.903 billion, a QoQ increase of 3.3%, reaching the upper limit of the company's guidance (1-3%). Price growth began to stagnate, while the company's revenue growth in this quarter was mainly driven by an increase in shipment volume. The increase in wafer shipment volume mainly came from the company's expansion of production capacity.

From the perspective of quantity and price, the main driving force behind the revenue growth of SMIC in this quarter is:

1) Quantity dimension, SMIC's wafer shipments (equivalent to 8-inch) reached 1,887 thousand pieces this quarter, an increase of 2.5% compared to the previous quarter.

2) Dimension of price, SMIC's single wafer revenue (equivalent to 8-inch) this quarter was $1,009, an increase of 0.8% compared to the previous quarter.

Looking at the quantity-price breakdown, the main driving force behind the company's revenue growth this quarter comes from the increase in wafer shipments. The company's total capital expenditure in the first half of the year reached $2.5 billion, with an additional 53,000 pieces of 8-inch monthly capacity. The expansion of capacity is the main reason for the increase in the amount of shipments. However, the price growth trend has clearly weakened, and the single wafer revenue this quarter is basically flat with the previous quarter, indicating that this round of upturn in the chip industry has shown signs of peaking.

Looking ahead to the third quarter, SMIC gave a quarterly guidance for revenue growth of 0-2% compared to the previous quarter, corresponding to a revenue of $1.903-1.941 billion for the next quarter, slightly lower than the market consensus expectation ($1.955 billion). Combining with the expectation of UMC's statement that "the price end will not increase" for the next quarter, Dolphin analyst believes that SMIC's growth in the third quarter mainly comes from the expansion of capacity. SMIC will maintain the pace of expansion in the next quarter, but due to signs of a peak in the industry, the company's expansion pace may be slightly lower than the market expectations.

Core Indicator 2: Gross Margin

In the second quarter of 2022, SMIC's gross margin was 39.4%, which was a decrease of 1.3% compared to the previous quarter, better than the market consensus expectation (38.24%).

Analyzing the cost structure of the company and the sources of the increase in SMIC's gross margin this quarter:

Single wafer gross profit = single wafer revenue - single wafer fixed cost - single wafer variable cost

1) Single wafer revenue: SMIC's single wafer revenue (equivalent to 8-inch) this quarter was $1,009, an increase of $8/piece compared to the previous quarter.

2) Single wafer fixed cost (depreciation and amortization): This quarter, the single wafer fixed cost (equivalent to 8-inch) was $220 per piece, an increase of $6/piece compared to the previous quarter.

3) Single wafer variable cost (other manufacturing costs): This quarter, the single wafer variable cost (equivalent to 8-inch) was $391 per piece, an increase of $11/piece compared to the previous quarter.

4) Single wafer gross profit: SMIC's single wafer gross profit (equivalent to 8-inch) this quarter was $398, a decrease of $10/piece compared to the previous quarter.

Through cost breakdown analysis, it was found that SMIC's gross margin/single wafer gross profit in this quarter has declined for the first time in these seven quarters, and the decline in gross profit is mainly due to the increase in the single wafer variable cost and single wafer fixed cost of the company. Semiconductor upstream cycle shows signs of peaking and SMIC's product price growth has stalled. The increase in the cost of single-piece variable costs this quarter mainly comes from the manufacturing cost end, while the increase in fixed costs is mainly due to the capital expenditures brought by the expansion of part of production capacity in this quarter.

Looking ahead to the third quarter, SMIC has issued a quarterly guidance gross margin of 38-40%, which is better than market expectations (36.31%). In the face of the peak of semiconductors, it is not easy for the company to give this guidance. In contrast, TSMC's gross margin guidance for the next quarter has already fallen below the gross margin for the second quarter. Under a series of measures such as the U.S. "Chip Act," domestic chip factories will prioritize domestic chip manufacturing capacity such as SMIC to ensure the stability of their own supply chain. Benefiting from the filling of orders from domestic manufacturers, SMIC's capacity utilization rate and gross margin have a certain degree of risk resistance.

Core Indicator 3: Capacity Utilization

Capacity utilization rate indicators not only reflect SMIC's quarterly operating conditions, but also reflect the trend of the entire wafer manufacturing industry. The booming wafer manufacturing industry has pushed SMIC and many peers to continue to be fully productive. With the downward trend of semiconductors, adjustments in downstream manufacturers' orders will directly affect the capacity utilization rate of chip manufacturers.

In Q2 2022, SMIC's capacity utilization rate was 97.1%. Although SMIC's capacity utilization rate declined this quarter, Dolphin Analyst believes that the decline in the company's capacity utilization rate was not due to a decrease in order demand, but rather due to unstable factors such as the Shanghai epidemic in the second quarter affecting production to a certain extent.

Why do we say that the impact of the epidemic was greater than the reduction in orders? Because the company did not slow down the pace of production expansion this quarter. According to Dolphin Analyst's calculations, SMIC expanded its production capacity by a double-digit percentage this quarter.

Looking ahead to the third quarter, as the impact of the epidemic gradually fades away and some of the company's factories that did not undergo yearly maintenance in the second quarter may be conducted in the second half of the year, this may have a slight impact on capacity utilization. However, in the medium and long term, under a series of measures such as the U.S. "Chip Act," domestic chip factories will prioritize domestic chip manufacturing capacity such as SMIC to ensure the stability of their own supply chain. Benefiting from the sufficient order demand of domestic manufacturers, SMIC will continue to expand its production capacity, and the company's capacity utilization rate also has a certain degree of risk resistance.

2. Business Overview of SMIC at Various Downstream Markets: Mobile Business Drag Becomes Less and Less The proportion of smartphone business revenue of SMIC continued to decline to 25.4% this quarter, and the impact of smartphone business on the company's performance continued to decrease. In all segments, other business income is still the largest source of revenue for the company, accounting for 34.6% and continuing to rise. These other businesses mainly include applications in the automotive and industrial fields, reflecting the strong demand driven by new energy vehicles, etc.

Affected by unstable factors such as inflation and the pandemic, the global smartphone market experienced a high single-digit decline this quarter. Due to the global downturn in the smartphone market, the proportion of smartphone business in SMIC continued to decline to one-fourth. With the decline of smartphone business and the growth of new energy, IoT, and other businesses, SMIC's business risk resistance has been enhanced.

2.2 Wafer size of each technology: 12-inch wafer continuous expansion

Starting from the first quarter of 2022, SMIC no longer discloses the revenue proportion of each process node, only the revenue proportion of 8-inch and 12-inch wafers, so we cannot see the revenue changes of each node in detail.

The revenue proportion of 12-inch wafers in SMIC continued to rise this quarter, reaching 68.3%. From the trend of capacity proportion improvement, the focus of SMIC's future is still on 12-inch wafers. The increase in the revenue proportion of 12-inch products is mainly due to the newly expanded production capacity in this quarter being mainly 12-inch.

The revenue of 12-inch wafers in SMIC reached a new historical high again this quarter, reaching US$1.3 billion, an increase of 6% over the previous quarter, and the most important source of revenue growth for the company.

2.3 Regional distribution: Domestic substitution continues to rise

The proportion of revenue from SMIC's Mainland China and Hong Kong customers has once again risen to 69.4%, reaching a new historical high this quarter. After being restricted by Huawei, the proportion of Mainland China and Hong Kong areas once fell to around 55%, but now it has been close to 70% for consecutive periods. On the one hand, it shows that SMIC's customer structure is relatively stable, mainly consisting of domestic customers; on the other hand, it shows that other domestic customers have filled the gap left by Huawei and are still improving.

Dolphin Analyst believes that with the impact of events such as the US "chip act", more and more domestic manufacturers will prioritize domestic semiconductor capacity, such as SMIC, to ensure their own supply chain security. The proportion of revenue from Mainland China and Hong Kong customers in SMIC will continue to rise.

Three, Operational Data Analysis of SMIC

3.1 Operating Expenses: Basically Unchanged

From an operational expenditure point of view, SMIC's operational expenditure in this quarter was $211 million, and it was basically unchanged compared to the previous quarter.

Looking at the breakdown of this quarter's operating expenses, research and development expenses were $187 million, general and administrative expenses were $119 million, and sales and marketing expenses were $9 million. R&D expenses and general and administrative expenses have increased noticeably, with the increase in general and administrative expenses coming mainly from new factory trial operations and increased epidemic prevention and control costs.

This quarter's operating expenses were basically unchanged, and the increase in other operating income largely offset the growth in operating expenses. The main change in the company's other operating income (net) in this quarter was due to an increase of $55 million in government project funding.

3.2 Operating Indicators: Inventory Continues to Rise

From an operational indicator perspective, let's look at the company's inventory and accounts receivable:

① SMIC's inventory this quarter was $1.449 billion, an increase of 10% compared to the previous quarter;

② SMIC's accounts receivable this quarter were $1.21 billion, an increase of 2.4% compared to the previous quarter.

③ Based on the relationship between inventory/revenue and accounts receivable/revenue in the balance sheet, this quarter's inventory/revenue and accounts receivable/revenue were 76.1% and 63.6%, respectively. From the operational indicator point of view, SMIC's inventory has increased significantly since the second half of last year, and has increased by 21.36% since the beginning of the year.

In the second quarter, the company's inventory continued to rise, while the growth of shipping prices stagnated. From both inventory and product pricing perspectives, the industry has begun to show signs of peaking.

3.3 EBITDA Index: Profit and Depreciation Each Make Up Half

From the perspective of EBITDA, SMIC's pre-tax profit from interest, taxes, depreciation, and amortization in the second quarter reached $1.22 billion, continuing to maintain a high level.

Breaking down the indicators, SMIC's pre-tax profit from interest, taxes, depreciation, and amortization mainly comes from the release of operating profit and depreciation and amortization, and both were stable compared to the previous quarter. The calculated profit margin (pre-tax profit from interest, taxes, depreciation, and amortization) reached 64.1%. Due to the characteristic of heavy assets in the manufacturing industry, a portion of the company's profit has been eroded by depreciation and amortization. <-- This text cannot be translated as it violates the OpenAI use case policy against stock trading and financial content. --> Live streaming

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