SMIC: Visible decline, but is being worse now better?

On the evening of February 9, 2023, Beijing time, Semiconductor Manufacturing International Corporation (0981.HK/688981.SH) released its 2022 Q4 financial report (as of December 2022) after the Hong Kong stock market closed. The key points are as follows:

1. Overall performance: Revenue missed expectations again. Semiconductor Manufacturing International Corporation achieved a revenue of 1.621 billion US dollars this quarter, a decrease of 15% compared to the previous quarter. The revenue barely reached the lower limit of the guidance (-10% to -15%), but was less than market expectations ($1.649 billion). The company's gross profit margin continued to fall to 32%, slightly exceeding market expectations (31.6%).

2. Observing the three core indicators: revenue, gross profit margin, and capacity utilization rate. The decline in revenue was mainly affected by the decrease in both volume and price due to the semiconductor downturn, which affected the company's shipment volume and product prices. In addition, the decline in the proportion of 12-inch wafers structurally lowered the average selling price. Under the continued weak downstream demand, the company's inventory continued to increase, and therefore, it also reduced its capacity utilization rate. The Company's capacity utilization rate dropped sharply from 92.4% in the previous quarter to a historical low of 79.5% this quarter, directly dragging down the company's gross margin.

3. Business progress: The market share of smartphones has rebounded slightly. The market share of the smartphone business continued to rebound this quarter, mainly due to the decline in the smart home and consumer electronics business. Although there is still no sign of obvious improvement in the demand side of smartphones, due to the measures taken by some manufacturers to digest inventory earlier, smartphones may have the opportunity to welcome an earlier "recovery from the difficulties". Affected by the weak downstream demand of some domestic customers, the proportion of China's revenue this quarter has fallen.

4. Next quarter guidance: SMIC expects revenue in Q1 2023 to decrease by 10%-12% quarter-over-quarter (corresponding to USD 1.43 billion-1.46 billion), significantly lower than market expectations ($1.524 billion); Gross profit margin 19%-21%, significantly lower than market expectations (26%).

Dolphin Analyst's overall view:

SMIC's financial report is still not good. Although the gross profit margin meets market expectations, the revenue end missed market expectations again. Compared with this quarter's performance, the guidance given by the company for the next quarter is even more pessimistic.

As Dolphin Analyst mentioned in his review of the previous financial report "SMIC: Long-term Belief, But Cannot Escape the "Cycle Curse"", "The company may further reduce its capacity utilization rate next quarter. In the semiconductor downturn cycle, the company's performance will also decline with the industry." In this quarter's financial report, the company's capacity utilization rate also surrendered a "surprising" 79.5% (a sharp decrease of 12.9% compared to the previous quarter). Regarding the guidance for next quarter, it's even less optimistic. Revenue is expected to continue to decline, with the company providing a guidance for a 10-12% QoQ decline, indicating that the company may still face a situation of simultaneous price and volume declines in the next quarter. Additionally, gross profit margin is expected to plummet, with the company only expecting a 19-21% margin for the next quarter. The Dolphin Analyst believes that the company's shipments in the next quarter will still struggle to recover. Faced with the continuously rising inventory levels, the company may continue to lower its capacity utilization rate on the one hand, and may adopt inventory write-downs on the other hand.

From a performance perspective, there are still no signs of improvement for SMIC currently. However, the Dolphin Analyst believes that the company has already started to respond to the current operating conditions, with a clear reduction in capacity utilization, which is partly aimed at shifting the focus to inventory digestion. Although the company's performance will face some pains in the short term against the backdrop of an unfavorable industry environment, only by facing the worst adversity, can it welcome the opportunity for a "reversal of the situation."

From an investment perspective, the market has already expected SMIC's poor performance. Although the quarterly report may fall short of expectations and could affect the confidence of some investors in the short term, the earlier the "bottom" comes, the earlier the "bottoming and rebounding" can be expected.

Indeed, the semiconductor industry is still in a downturn, but some downstream semiconductor companies have already shown signs of inventory digestion. The Dolphin Analyst maintains the view in the article "Semiconductor Avalanche? The most severe downturn will bring real flexibility" that "the semiconductor industry is still in the left-hand interval, but stock prices often lead the industry in advance."

Regarding this financial report, Dolphin Analyst mainly focuses on the following issues:

Overall performance vs market expectations: How does SMIC's performance in the three core indicators, revenue, gross profit margin, and capacity utilization, perform during the semiconductor downturn?
Specific sources of revenue growth: For the revenue of the company this quarter, how much is contributed by volume and price respectively? Is the decline in semiconductor industry affecting the company's shipment volume and price?
Sources of gross profit margin improvement: Can the company's gross profit margin meet expectations this quarter? How have prices and cost changed?
Business development: How is SMIC's downstream performance? What is the progress of domestic semiconductor customers?
Performance in operation: What are the changes in SMIC's operating aspects this quarter? Are the inventory and accounts receivable reasonable? How about EBITDA?

Here is Dolphin Analyst's detailed analysis:

I. An Analysis of SMIC's Core Indicators: Revenue, Gross Profit Margin, and Capacity Utilization Rate

Core Indicator 1: Revenue

In the fourth quarter of 2022, SMIC achieved revenue of 1.621 billion U.S. dollars, a QoQ decrease of 15%, lower than market expectations (1.649 billion U.S. dollars). This quarter the company began to experience a simultaneous decline in both price and volume, indicating that SMIC was also significantly affected by the downward cycle of the semiconductor industry. From the perspective of quantity and price, the main factors influencing the decline in revenue of SMIC International in this quarter are:

1) In terms of quantity, SMIC International's wafer shipments (equivalent to 8-inch) in this quarter reached 1,574 thousand pieces, a decrease of 12.4% from the previous quarter;

2) In terms of price, SMIC International’s single wafer revenue (equivalent to 8-inch) in this quarter was $1,030, a decrease of 2.9% from the previous quarter.

From the breakdown of quantity and price, the revenue decline of the company this quarter was affected by both the quantity and price decreases, with the impact of shipments relatively greater.

In recent quarters, SMIC International's inventory has continued to rise, and a sluggish downstream market has directly affected the double-digit decline in shipments this quarter. At the same time, under the influence of the industry's overall declining product prices, it is difficult to maintain the previous performance improvement.

Affected by the downturn of the industry cycle and the increase in company inventory, the company's capital expenditure this quarter was slightly lower than expected. By the end of the fourth quarter, the company's wafer production capacity (equivalent to 8-inch) was 1,980 thousand pieces, a quarter-on-quarter increase of 1.4%. The actual capital expenditure completed this quarter was slightly reduced compared to the expectation at the end of the third quarter, and the total capital expenditure for 2022 is expected to be US$6.35 billion (lower than the previous expectation of US$6.6 billion).

Looking ahead to the first quarter of 2023, SMIC International has given a quarterly guidance of a 10%-12% decline in revenue compared to the previous quarter, and the company is expected to achieve revenue of US$1.43-1.46 billion in the next quarter, much lower than the market consensus forecast ($1.524 billion). Dolphin Analyst believes that the company will still be affected by the industry in the next quarter, and the quantity and price of the company's products will still be under pressure.

Core Indicator 2: Gross Margin

In the fourth quarter of 2022, the gross margin of SMIC International was 32%, a decrease of 6.9 percentage points from the previous quarter, which was slightly higher than the market consensus forecast (31.6%).

Splitting the cost structure of the company and analyzing the source of the increase in gross margin in this quarter of SMIC International:

Gross profit per unit = Single wafer revenue - Single wafer fixed cost - Single wafer variable cost

1) Single wafer revenue: SMIC International’s single wafer revenue (equivalent to 8-inch) in this quarter was $1,030, a decrease of $31 per piece from the previous quarter.

2) Single wafer fixed cost (depreciation and amortization): The single wafer fixed cost (equivalent to 8 inches) this quarter was $261, an increase of $31 per piece from the previous quarter.

3) Single wafer variable cost (other manufacturing costs): The single wafer variable cost (equivalent to 8-inch) of this quarter was $439, an increase of $21 per piece from the previous quarter. 4) Single Chip Gross Margin: SMIC's single chip gross margin (equivalent to 8 inches) this quarter was $330, a decrease of $83 per chip compared to the previous quarter.

By breaking down the costs, SMIC's gross margin rate declined again this quarter. The decline in gross margin rate this quarter was due to a decrease in product prices and an increase in unit costs, causing the company's gross margin rate to plummet from 38.9% to 32%.

Specifically, (1) Unit fixed costs increased: SMIC's depreciation and amortization total for this quarter did not change significantly, but the increase in unit fixed costs was mainly due to a decrease in the company's shipments this quarter, which increased the cost per chip; (2) Unit variable costs increased: The total variable cost for this quarter has decreased, partly because some variable costs are related to shipments. However, there are still some variable costs that do not change with shipment volume, which have contributed to the increase in per-chip variable costs this quarter.

Looking ahead to the first quarter of 2023, SMIC provided quarterly gross margin guidance of 19-21%, which is much lower than the market consensus of 26%. The company is still expected to be affected by the industry's weakness in the next quarter, and there is little room for improvement in gross margin. Regarding such a sharp drop in gross margin, Dolphin Analyst believes that the possible factors may include: (1) some product prices in the industry are still falling; (2) the company's shipments and capacity utilization rate will remain low in the next quarter; (3) under the continuous pressure of high inventories, the company may have the possibility of inventory impairment.

Core Metric 3: Capacity Utilization Rate

Capacity utilization rate not only reflects SMIC's quarterly operating performance, but also reflects the trend of the entire wafer manufacturing industry. As the wafer manufacturing industry prospers, SMIC and many other peers continue to experience full capacity production. However, as the semiconductor industry shows signs of decline, downstream vendor order adjustments will directly affect the capacity utilization rate of chip manufacturers.

In the fourth quarter of 2022, SMIC's capacity utilization rate was 79.5%. SMIC's capacity utilization rate collapsed this quarter, with 79.5% being a "rare" new low for the company's capacity utilization rate, which also indicates that the industry has entered a "winter".

Looking ahead to the first quarter of 2023, although the company's capacity utilization rate hit a new low this quarter, it is still difficult to see any significant improvement in the next quarter. Based on the revenue and gross margin guidance provided by the company, Dolphin Analyst expects that the company's capacity utilization rate may hit another new low in the next quarter.

2. Business Perspective on SMIC

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

2.1 Market performance: Smartphone market share rebounds slightly

The revenue share of smartphone business for SMIC continues to rise to 28.6% this quarter, mainly due to the decline in smart home and consumer electronics. Meanwhile, the revenue of other businesses continues to increase, accounting for 39% this quarter, significantly ahead of the first three business categories. Among these, the main focus is on applications in areas such as automobiles, industry, and new energies.

Upon closer inspection of SMIC's downstream, smart home and consumer electronics businesses experienced a significant quarter-on-quarter decline, as these two have more discretionary attributes and are affected by the overall consumption environment. However, the smartphone business, which has seen declining shares in previous quarters, continued to show a stabilizing trend this quarter. Although there is still no sign of significant improvement in smartphone demand, Dolphin Analyst believes that due to the measures taken by some manufacturers, such as early inventory digestion, smartphones may have the opportunity to recover earlier from the "difficulties".

Although the growth rate of smartphone businesses is unlikely to return to previous levels, such businesses will still occupy a relatively significant share. In terms of company business, the share will account for more than 20%.

2.2 Wafer size distribution: Sudden drop in 12-inch wafer production

Since 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. Therefore, it is impossible to observe the revenue changes of each node in detail.

This quarter, the revenue share of 12-inch wafers from SMIC has declined slightly, falling to 64.4%. Since the revenue share of 12-inch wafers declined this quarter, it has had some impact on the company's average selling price. Regarding the decline in the revenue share of 12-inch wafers this quarter, this is mainly due to some 12-inch customers of the company lowering their shipment needs for this quarter under the influence of weak demand.

Dolphin Analyst believes that the decline in the share of 12-inch wafers is a short-term phenomenon, and it will remain the focus of the company's development in the future. Judging from previous production capacity and capital expenditures, SMIC will continue to increase the proportion of 12-inch products.

2.3 Regional Distribution: China's revenue declined

This quarter, SMIC adjusted the regional revenue distribution criteria from the original "North America/China Mainland and Hong Kong/Europe and Asia" to the current "China Region/US Region/Euro-Asia Region". Due to the adjustment in the criteria, the data has some differences.

Specifically: ①China Region: Revenue share is 69.1%, a 6% decrease from the previous quarter; ②US Region: Revenue share is 25.3%, up 4.8% from the previous quarter; ③Euro-Asia Region: Revenue share is 5.6%, up 0.8% from the previous quarter. From the regional revenue of this quarter, the revenue in China has shown a significant decline. The main reason is that there has been a significant decline in sales of smart home and consumer electronics this quarter, mainly from Chinese customers. The insufficient cargo pulling force of customers directly affected the revenue performance of China this quarter.

III. Business Data of SMIC

3.1 Operating expenses: a slight fall

From the perspective of operating expenses, SMIC's operating expenses this quarter were USD 236 million, a decrease from the previous quarter.

Breaking down the operating expenses of this quarter, research and development expenses were USD 197 million, general and administrative expenses were USD 127 million, and sales and marketing expenses were USD 8 million. R&D expenses have increased compared to the previous quarter, while general and administrative expenses have decreased significantly, with the increase mainly coming from the commissioning of the new factory this quarter.

Although R&D investment has increased this quarter, operating expenses have decreased due to the larger decrease in general and administrative expenses.

3.2 Operating indicators: Peak inventory ratio

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

①SMIC's inventory this quarter was USD 1.91 billion, an increase of 12.6% compared to the previous quarter;

②SMIC's accounts receivable this quarter was USD 1.303 billion, an increase of 7.2% compared to the previous quarter.

③Combining the relationship between inventory/accounts receivable in the balance sheet and revenue, the inventory/revenue and accounts receivable/revenue this quarter were 118% and 80%, respectively. From the perspective of operating indicators, SMIC's inventory continues to rise and has reached a historical peak.

By combining the company's inventory and capacity utilization rate data, you can basically see the company's trend. The company's capacity utilization rate was close to full in the first quarter of 2022. As the company's inventory has continued to rise since the first quarter of 2022, the capacity utilization rate has decreased since the second quarter. Therefore, combined with the current inventory situation, the Dolphin Analyst expects that the capacity utilization rate in the first quarter of 2023 may continue to decrease to prioritize the disposal of the company's existing inventory.

3.3 EBITDA indicators: Profit and depreciation account for half each

From the perspective of EBITDA, SMIC's profit before taxes, interest, depreciation and amortization in the fourth quarter reached USD 1.063 billion, which continued to maintain a high level.

Breaking down the indicators, SMIC's profit before taxes, interest, depreciation, and amortization mainly came from the release of operating profits and depreciation and amortization, with profits continuing to decrease and depreciation and amortization continuing to increase this quarter. The profit margin (before taxes, interest, depreciation, and amortization) for this quarter was calculated to be 65.6%.

The company’s profits are largely eroded by depreciation and amortization due to the heavy asset characteristics of the manufacturing industry.

Dolphin Analyst reviews on the history of SMIC:

Earnings Report Season

November 11, 2022 Phone Call "Despite Semiconductor Downturn, Capex Preserved (SMIC 22Q3 Phone Call)"

November 11, 2022 Financial Report Review "SMIC: Long-Term Faith, Struggling in 'Cycle Curse'"

August 12, 2022 "How will SMIC Respond to the Semiconductor Downturn? (22Q2 Phone Call Overview)"

August 11, 2022 "Prices Cannot Rise Anymore, SMIC Resolutely Faces 'Cycle Crisis'"

May 13, 2022 Phone Call "Limited Impact from Pandemic, Semiconductor Presents Structural Shortage (SMIC Phone Call Summary)"

May 12, 2022 Financial Report Review "Pandemic and Market Crisis? SMIC's Performance Will Not 'Crash'"

February 11, 2022 Phone Call "In addition to Industry Inflation, SMIC Expands Production"

February 10, 2022 Financial Report Review "SMIC Continues to Soar with Performance Despite Inflation"

November 12, 2021 Phone Call "What did the SMIC Management Discuss after Performance Exceeded Expectations but Experienced a Major Downturn?"

November 11, 2021 Financial Report Review "SMIC Remains Strong Despite Doubts About the End of the Cycle" 2021 年 8 月 6 日 Telephone Conference "How does SMIC management view 21Q2 financial results？"

August 5, 2021 Financial Report Review "SMIC: The Rising Power of China's Semiconductor Industry"

In Depth

December 29, 2022 "Semiconductor avalanche? True resilience comes after the most devastating decline"

June 24, 2022 Industry Depth Report "Are Semiconductors Really Going to Change?"

July 16, 2021 Company Depth Report "SMIC International (2): The Underrated Power of China's Semiconductor Industry"

July 9, 2021 Company Depth Report "SMIC International (1): On the Core Technology Strategy of a Leading Chinese Semiconductor Company"

Live Broadcasting

May 13, 2022 "SMIC International (00981.HK) 2022 Q1 Results Telephone Conference"

February 11, 2022 "SMIC International (00981.HK) 2021 Q4 Results Telephone Conference"

November 12, 2021 "SMIC International (00981.HK) 2021 Q3 Results Telephone Conference"

August 6, 2021 "SMIC International (00981.HK) 2021 Q2 Results Telephone Conference"

May 14, 2021 "SMIC International (00981.HK) 2021 Q1 Results Telephone Conference" This article's risk disclosure and statement: Dolphin Research's Disclaimer and General Disclosure