SMIC: Counter-cyclical expansion, leading to a collapse guidance.

On the evening of February 6, 2023, SMIC (0981.HK/688981.SH) released its fourth-quarter earnings report for the year 2023 (ending in December 2023) after the Hong Kong stock market closed. The key points are as follows:

Overall performance: Average. SMIC achieved revenue of $1.678 billion in this quarter, a 3.5% increase MoM, exceeding the upper limit of the company's guidance (1% to 3%), and slightly surpassing market expectations ($1.658 billion). The company's gross margin continued to decline to 16.4%, lower than market expectations (17.5%).

Detailed analysis of the three core indicators: revenue, gross margin, and capacity utilization rate. On the revenue side, SMIC's revenue rebounded mainly due to the increase in shipment volume, while prices continued to decline. Although there was an increase in shipment volume, the company's capacity utilization rate remained low this quarter due to the impact of capacity expansion. It is worth noting that downstream demand is still weak, and the company's inventory reached a new high this quarter.

Business progress: Both the mobile phone and PC sectors showed signs of recovery. With the release of new products by downstream manufacturers, the mobile phone business accounted for 30% of the total revenue. After a long period of destocking, the PC industry also showed signs of demand recovery from downstream manufacturers. The proportion of revenue from the Chinese market continued to account for more than 80%, and the company's business still relies mainly on domestic customers.

Guidance for the next quarter: SMIC expects a 2% QoQ increase in revenue for the first quarter of 2024, corresponding to $1.71 billion, slightly better than market consensus ($1.67 billion); gross margin of 9-11%, significantly lower than market expectations (16.59%).

Overall, SMIC's earnings report this time was average. Revenue slightly exceeded market expectations, while the gross margin performed below market expectations but still within the company's guidance range. Looking at the detailed data, the average selling price of the company's products continued to decline, and the company's inventory continued to rise. The company has not shown signs of improvement due to the overall industry downturn.

Considering the company's guidance for the next quarter, SMIC expects a 2% QoQ increase in revenue for the first quarter of 2024, but the gross margin will continue to decline to around 10%. The company will continue to face pressure from high inventory in the next quarter, and the capacity utilization rate will remain relatively low, directly affecting the company's gross margin. Counter-cyclical expansion has both positive and negative aspects. Expansion ensures SMIC's production capacity, which is a good thing. However, the increased depreciation and amortization will also drag down the company's short-term performance.

With TSMC's continuous mass production of 3nm chips, the proportion of advanced processes has reached nearly 70%. The gap between SMIC and TSMC will widen again, evolving into a two-tier competition. The company's main business is still concentrated in traditional processes, which is greatly influenced by the semiconductor industry and its cycles. If SMIC cannot surpass the cyclicality, the overall valuation of the company will be relatively limited.

Here is Dolphin Research's detailed analysis of SMIC:

I. Key indicators of SMIC: Revenue, Gross Margin, and Capacity Utilization

Key Indicator 1: Revenue

In Q4 2023, SMIC achieved revenue of $1.678 billion, a MoM increase of 3.6%, slightly exceeding expectations (MoM growth of 1-3%). The company's shipment volume continued to recover this quarter, while prices continued to decline.

Analyzing the specific factors affecting SMIC's revenue growth from the perspectives of volume and price:

1) Volume: SMIC's wafer shipments (8-inch equivalent) reached 1,675 thousand pieces this quarter, a MoM increase of 9%;

2) Price: SMIC's average wafer revenue (8-inch equivalent) was $1,002, a MoM decrease of 5%.

From the breakdown of volume and price, the revenue rebound this quarter was mainly driven by the increase in shipment volume, while product prices continued to decline.

Although the company and the industry are still in a downturn, the company's capital expenditure has significantly increased this quarter. The company's capital expenditure this quarter was $2.341 billion, a YoY increase of 17.8%. Dolphin Research believes that the company accelerated the procurement of lithography machines and other equipment before the export license for immersion lithography equipment of NXT:2000i and above to mainland China expires on January 1, 2024.

Looking ahead to Q1 2024, SMIC has provided a quarterly guidance of 2% QoQ revenue growth, corresponding to an expected revenue of $1.71 billion for the next quarter, slightly better than the market consensus of $1.67 billion **. Dolphin Research believes that some downstream customers of the company have a demand for replenishing inventory and stocking up, which in turn drives the increase in the company's shipment volume. However, the industry downturn has not shown signs of price recovery.

Core Indicator 2: Gross Margin

In the fourth quarter of 2023, SMIC's gross margin was 16.4%, a MoM decrease of 3.4pct, lower than market expectations (17.5%).

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

Gross profit per wafer = Wafer revenue per wafer - Fixed cost per wafer - Variable cost per wafer

Wafer revenue per wafer: SMIC's wafer revenue per wafer (equivalent to 8 inches) this quarter was $1002, a MoM decrease of $53 per wafer.

Fixed cost per wafer (depreciation and amortization): The fixed cost per wafer (equivalent to 8 inches) this quarter was $360, a MoM increase of $22 per wafer.

Variable cost per wafer (other manufacturing expenses): The variable cost per wafer (equivalent to 8 inches) this quarter was $478, a MoM decrease of $30 per wafer.

Gross profit per wafer: SMIC's gross profit per wafer (equivalent to 8 inches) this quarter was $164, a MoM decrease of $45 per wafer.

Through cost breakdown, it is found that SMIC's gross margin declined MoM this quarter mainly due to the decrease in unit revenue and the increase in unit fixed costs. With the increase in capital expenditure, the company's depreciation and amortization expenses have increased. The counter-cyclical expansion further lowered the company's gross margin.

Looking ahead to the first quarter of 2024, SMIC has given a quarterly gross margin guidance of 9-11%, lower than market expectations (16.59%). Dolphin Research believes that this is mainly due to two reasons: 1) the current industry cycle is still weak, putting pressure on the company's product average selling price; 2) the company's expansion has increased depreciation and amortization expenses, further lowering the company's gross margin level.

Core Indicator 3: Capacity Utilization Rate

The capacity utilization rate not only reflects SMIC's quarterly operating conditions, but also reflects the overall prosperity trend of the wafer manufacturing industry. With the relative downturn in the semiconductor industry, adjustments in downstream manufacturers' orders will directly affect the capacity utilization rate of chip manufacturers.

In the fourth quarter of 2023, SMIC's capacity utilization rate was 76.8%, which continued to remain low this quarter. Dolphin Research believes that although the company's shipment volume has increased this quarter, the capacity utilization rate remains low, mainly due to the company's recent counter-cyclical expansion.

Looking ahead to the first quarter of 2024, although the company's shipment volume has increased due to the demand for downstream customer replenishment, the company's capacity utilization rate will remain low as it continues to expand production.

II. let's take a comprehensive look at SMIC's quarterly business situation:

In terms of downstream markets, the proportion of revenue from SMIC's smartphone business in this quarter is 30.2%, showing a significant improvement. This is mainly due to the release of new smartphones by manufacturers in the fourth quarter, which has boosted the company's smartphone business.

The company has segmented its other businesses this quarter, with the proportion of revenue from computer and tablet business at 30.6% and the industrial and automotive business at a lower proportion of 7.6%. The computer and tablet business, apart from smartphones, has also shown improvement. This is mainly due to signs of recovery in the PC industry after a long period of decline, with downstream customers seeing a rebound in demand.

SMIC no longer discloses the revenue proportion of each process node since the first quarter of 2022, only disclosing the revenue proportion of 8-inch and 12-inch wafers. This makes it impossible to see the revenue changes of each node in detail.

In this quarter, the proportion of revenue from 12-inch wafers maintained a high level of 74.2%, with little difference from the previous quarter. Looking at the proportion of the two sizes and the company's revenue, the revenue from 12-inch chips increased by 3.8% compared to the previous quarter, while the revenue from 8-inch wafers increased by 2.8%.

SMIC has adjusted the geographical distribution of revenue, changing from the previous "North America/China Mainland and Hong Kong/Europe and Asia" to the current "China Region/US Region/Euro-Asia Region". Due to this adjustment, there are slight differences in the data.

Looking at the regional revenue in this quarter, the revenue from the China region continues to account for about 80%, making it the company's main source of income. The decline in the proportion of revenue from the China region and the increase in the proportion of revenue from the US region are mainly influenced by the seasonal demand from major US customers.

III.In terms of operating data, overall expenses remain stable.

From the perspective of operating expenses, SMIC's operating expenses this quarter were $168 million, a decrease mainly due to an increase in other operating income this quarter.

Breaking down the operating expenses for this quarter, research and development expenses were $189 million, general and administrative expenses were $148 million, and sales and marketing expenses were $9 million. Among them, administrative expenses increased mainly due to the increase in start-up expenses for new factories this quarter.

From the perspective of operating indicators, the main observations are from the company's inventory and accounts receivable:

① SMIC's inventory this quarter was $2.736 billion, an increase of 6.2% compared to the previous quarter;

② SMIC's accounts receivable this quarter was $1.17 billion, a decrease of 4% compared to the previous quarter.

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 163% and 70%, respectively. From the perspective of operational indicators, SMIC's inventory continues to rise, reaching a historical high.

Combining the company's inventory and capacity utilization data, we can see the company's trend. In the first quarter of 2022, the company's capacity utilization rate was still close to full capacity. As the company's inventory has continued to rise since the first quarter of 2022, the capacity utilization rate has started to decline from the second quarter. Therefore, considering the current inventory situation, Dolphin Research expects that the capacity utilization rate in the first quarter of 2024 will remain relatively low, and the high inventory will still be a problem that the company needs to address.

From the perspective of EBITDA, SMIC's pre-tax and pre-depreciation and amortization profit this quarter was $1.011 billion, showing a slight recovery.

Breaking down the indicators, SMIC's pre-tax and pre-depreciation and amortization profit mainly comes from the release of operating profit and depreciation and amortization. The recovery this quarter is mainly due to the increase in profit (which Dolphin Research believes is mainly due to the impact from non-core business) **. The profit margin (pre-tax and pre-depreciation and amortization) for this quarter has increased to 60.2%. Due to the heavy asset nature of the manufacturing industry, most of the company's profits are eroded by depreciation and amortization.

Dolphin Research's historical articles on SMIC:

Earnings Season

November 10, 2023: Conference Call - "W-shaped Recovery, Delayed or Postponed for a Year? (SMIC 3Q23 Conference Call)"
November 10, 2023: Earnings Review - "SMIC: A Long Cycle, Waiting for the Favorable Wind"
August 11, 2023: Conference Call - "Incremental Growth in Mobile Phones from 'Trade-In' Programs? (SMIC 2Q23 Conference Call)"
August 11, 2023: Earnings Review - "SMIC: How Long Do We Have to Wait for Recovery?"
May 12, 2023: Conference Call - "12-inch Urgent Orders, Semiconductor Industry Begins Structured Recovery (SMIC 1Q23 Conference Call)"
May 11, 2023: Earnings Review - "SMIC: Shining Through the Semiconductor Cycle"
February 10, 2023: Conference Call - "High Depreciation Pressuring Gross Margin, Improvement Expected in the Second Half (SMIC 4Q22 Conference Call Summary)"
February 10, 2023: Earnings Review - "SMIC: Visible Downturn, But Is Bad News Good News Now?"
November 11, 2022: Conference Call - "Capital Expenditure Remains Unchanged Despite Semiconductor Downturn (SMIC 3Q22 Conference Call)"
November 11, 2022: Earnings Review - "SMIC: Long-Term Belief, Yet Unable to Escape the 'Cycle Curse'"
August 12, 2022: "How Will SMIC Respond to the Semiconductor Downturn? (2Q22 Conference Call Summary)" On August 11, 2022, "Price Stagnation, SMIC Resists the "Cyclical Robbery"" was published on Longbridge.

On May 13, 2022, the conference call "Limited Impact of the Epidemic, Semiconductor Faces Structural Shortage (Summary of SMIC Conference Call)" was held.

On May 12, 2022, the earnings report review "Epidemic and Market Struggles? SMIC's Performance Remains Strong" was published.

On February 11, 2022, the conference call "Alpha Beyond Industry Price Increases, SMIC Expands Production" took place.

On February 10, 2022, the earnings report review "SMIC: Continuous Growth Amidst Price Increases" was published.

On November 12, 2021, the conference call "After Exceeding Expectations, SMIC Faces a Major Drop, What Did the Management Discuss?" was held.

On November 11, 2021, the earnings report review "Don't Doubt the Peak of the Cycle, SMIC Still Going Strong!" was published.

On August 6, 2021, the conference call "How Does the Management View SMIC's 21Q2 Earnings Report?" took place.

On August 5, 2021, the earnings report review "SMIC: The Rising Force of China's Semiconductor Industry" was published.

In-depth Analysis

On December 29, 2022, "Semiconductor Avalanche? True Resilience Only After the Most Brutal Decline" was published on Longport.

On June 24, 2022, the industry in-depth analysis "Order Cancellations, Is the Semiconductor Industry Really Going to Change?" was published.

On July 16, 2021, the company in-depth analysis "SMIC (Part 2): The Underestimated Chinese "Chip"" was published. On July 9, 2021, the company released an in-depth article titled "SMIC (Part 1): The Attack Strategy of the Leading Chipmaker".

Live Broadcast

On May 13, 2022, the "SMIC (00981.HK) Q1 2022 Earnings Conference Call" was held.

On February 11, 2022, the "SMIC (00981.HK) Q4 2021 Earnings Conference Call" was held.

On November 12, 2021, the "SMIC (00981.HK) Q3 2021 Earnings Conference Call" was held.

On August 6, 2021, the "SMIC (00981.HK) Q2 2021 Earnings Conference Call" was held.

On May 14, 2021, the "SMIC (00981.HK) Q1 2021 Earnings Conference Call" was held.

Risk disclosure and statement for this article: Dolphin Research Disclaimer and General Disclosure