Company Overview

Semiconductor Manufacturing International Corporation (SMIC) is one of the leading foundries with its headquarters in Shanghai, China. It is a limited liability company registered in Cayman Islands in April 2000. The shares of SMIC are traded on the Hong Kong Stock Exchange and the Science and Technology Innovation Board of the Shanghai Stock Exchange.

SMIC’s main semiconductor products, 8-inch and 12-inch wafers, are used in smartphones, computers, tablets, consumer electronics, the Internet of Things (IoT) and the automotive industry. It also provides support services such as design and technical services related to integrated circuits, photomask manufacturing and other services. The company has fabs in locations across China such as Shanghai, Beijing, Shenzhen and Tianjin.

SMIC has been spending on the upgrade of its capacity in order to meet the demand for its products. In addition, investment in technology ensures that it keeps pace with competitors.  

Liu Xunfeng chairs a nine-man board of directors of the company. Zhao Haijun and Liang Mong Song are the chief executive officers of SMIC.

Investment Thesis

SMIC is an integrated company that provides solutions that cut across the semiconductor supply chain. It provides integrated circuit solutions like integrated circuit design, manufacturing, testing and packaging. The company leverages its comprehensive product portfolio to grow its business by fulfilling the demand of customers at different stages of the industry supply chain.

The company seems to have recovered from the dip in performance that occurred in the preceding year (2023). In 2024, it increased the quantity of silicon wafers delivered by 36.7% as against the 17.4% decline recorded in the previous year. Wafer sales, as a result, rose from US$5.8 billion in 2023 to US$7.5 billion in 2024. Wafer sales form over 90% of the company’s total revenue. Total revenue and net income increased by 14.6% and 16.3%, respectively, on a 7-Year Compound Annual Growth Rate (CAGR) basis.

Over the past three years, sales revenue from America has decreased by 6.5% while sales to Eurasia (Europe and Asia) has declined by 17.4%. Sales, however, grew at a 3-Year CAGR of 21.4%.

SMIC is cash-rich, generating enough operating cash flow to pay off its interest on debt. However, huge costs and rising debt have impacted its profitability in the past two years.

The company has been slowly losing ground in the US, its major foreign market. Now, it relies on domestic sales as most of the sales were made to customers in China (2024: 84.7% of total revenue); America was responsible for only 12.4% of total revenue as against over 20% in 2021. We are of the opinion that increased penetration of markets outside China would give the company cost savings and boost its profit margins.

Innovation propelled by continuous Research & Development (R&D) spending is a critical success factor in the industry. Expectedly, SMIC has been working with top universities and research institutes to ensure it does not lag behind its competitors. Its R&D spending averaged 14% of revenue over the past ten years. Huge R&D expenses result in thin profit margins.

Furthermore, semiconductor production is a highly capital-intensive undertaking as it requires massive investment. Capital expenditure (CAPEX) of $7.7 billion in 2024 was tantamount to a compound annual growth rate of 20.9% over the past three years. Huge CAPEX has been responsible for the inability of the company to generate positive free cash flow for the shareholders. Dividend yield is 0% because it does not pay dividends to shareholders at the moment.

SMIC is profitable; it is not insolvent in our opinion. The semiconductor industry is one of the strategic industries encouraged by the Chinese government. As such, SMIC receives assistance from the Chinese government in terms of tax incentives and funding for the purpose of helping the country achieve self-sufficiency in chip manufacturing. The company also stands to benefit from strong global demand for electronics and smartphones. Based on our analysis of the company’s fundamentals, its shares appear overpriced at the current market price of HK$40.80 (US$5.21) on the Hong Kong Stock Exchange.

Valuation

SMIC’s Book Value Per Share of US$4.00 at the end of 2024 exceeded its 10-year average of US$2.58. Our fair value estimate of a share in the company is between US$3.12 (HK$24.45) and US$4.00 (HK$31.35). The anticipated return on a share of the company is 21%, which is primarily due to capital appreciation.

Financial Overview

The revenue of SMIC grew by 27% to US$8 billion in 2024 compared to the previous year, when it shed 13.1% year-over-year. Wafer sales accounted for US$7.5 billion or 93.2% of total revenue in 2024 (2023: US$5.8 billion or 91.7% of total revenue). Mask making, testing & others segment produced US$543 million or 6.8% of total revenue (2023: US$527.1 million or 8.3% of total revenue). China was responsible for 84.7% of sales revenue (2023: 80.1%) of SMIC, America produced 12.4% (2023: 16.4%), while Eurasia accounted for 3% (2023: 3.6%).

The bulk of the wafer sales were for application in consumer electronics and smartphones. The sale of wafers for consumer electronics was 38% of wafer sales as against 25% in the prior year. Smartphone application accounted for 28% of wafer sales in 2024 compared to 27% in 2023. There was a drastic drop in the contribution of computer and tablet application to wafer sales from 27% to 16%.

Gross profit jumped 18.9% to US$1.4 billion despite a 29% hike in cost of sales in the year. Gross profit margin lost 1.2% to close at 18% at 2024 year-end. Operating profit in 2024 was US$62.7 million, recovering from the US$6.7 million operating loss of the previous year.

Profit Before Tax (PBT) and Profit After Tax (PAT) decreased by 27.6% and 35.1 % year-over-year, respectively, to US$859.6 million and US$730 million. PBT margin was 10.7%, down from 18.8%. PAT margin, likewise, shed 8.7% in one year.

Total assets and shareholders’ fund grew by 2.9% and 3.3% respectively. Total debt increased from US$10.2 billion to US$11.6 billion. Total debt amounted to 23.6% of total assets (2023: 21.4%) and 36.4% of total equity (2023: 33.1%). SMIC’s net debt stood at US$5.2 billion (2023: US$4 billion). The company generates adequate cash flow to offset its debt obligations. In 2024, cash flow covered interest payment 10.7 times. However, operating profit for the year covered it 0.2 time. The current ratio stood at 1.7 times while acid test ratio was 1.4 times. SMIC is neither insolvent nor illiquid.

Business Risk

There is intense competition in the global semiconductor industry, which may put downward pressure on profit margins and cause overcapacity. In addition, the ability of SMIC to thrive in America, its largest foreign market, is doubtful in the medium term owing to restrictions from the American government. Increasing market penetration in Europe and rising demand for smartphones and electronics in emerging markets could help bolster its earnings going forward.

The business is susceptible to global economic conditions that can make its earnings volatile; a rising demand for smartphones, electronics, computers, etc., can lead to expansion, while a shrinking global economy can cause a fall in its earnings. SMIC is involved in a considerable amount of transactions involving multiple currencies, thereby exposing it to exchange rate fluctuations.
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Recommendation: Overpriced