The development potential of Semiconductor Manufacturing International

Current price: $29.3   Target Price: $36.43   Recommendation: Buy

Semiconductor Manufacturing International Corp. engages in the production and sale of semiconductor products. It provides integrated circuit foundry and technology services, as well as technology solutions for logic, mixed-signal and radio frequency, high voltage, system on a chip, flash, and electrically erasable programmable read-only memory (EEPROM) circuits.

Revenue Analysis:
For the year ended 31 December 2019, SMIC showed a 7.26% revenue decrease, in contrast to the global semiconductor industry’s 12% year-over-year decline. In between, 34% of revenue comes from sales of custom-made semiconductors to customers like Huawei; 60% of total revenue are contributed from China market.

Semiconductor Market Share Analysis:
In Q2 2019, major semiconductors producers are mainly: TSMC (51.5%), Samsung Electronics (18.8%), GlobalFoundries (7.4%), UMC (7.3%). Although SMIC is now out of top 3 in global foundry industry and has just debuted on Sci-Tech Board in July, the market value of SMIC is already over a quarter of TSMC, which ranked in the top of the industry. There is great growth potential in the future.

Future Prospection

Elevation of sales from Huawei

In March, Reuters reported that the Trump administration agreed to new restrictions on Huawei. The rules would require foreign firms to apply for a license before selling to Huawei. Hence, Huawei has moved from TSMC to SMIC to power one of its flagship smartphones. This would probably increase sales in SMIC in the future, since Huawei is one of the second-largest manufacturer of smartphones in the world, behind Samsung Electronics.

Higher than average PE ratios proves record of success

Q2 2020 mentioned that SMIC has a PE ratio of 92.54, which is 3 times higher than the industry average of 25.07 and other competitors, for instance TSMC(21.77) and UMC(18.69). A high PE ratio suggests that investors expect a high level of earnings in the future, and that growth will be strong. The share price has risen faster than earnings, on expectations of an improvement in performance.

Risk

Overreliance on China market

In Q4 2019, 60% of the revenue comes from China market, only 26% comes from North America, which is less than half of the revenue derived from China market. With the new US carb, in which US barred any chipmaker using American equipment from supplying the networking giant without U.S. approval. This would probably reduce sales from US. Besides, US may tighten restrictions on the sale of technology to China, threatening to deny domestic companies like SMIC access to crucial components and circuitry.

Valuation

Using the conservative forward P/E multiple of 100 and Thomson Reuters 2021 consensus earnings per share $0.047, this gives us a price of HK$36.43, which indicates around 20% undervaluation of this stock.

We used 100 P/E multiples since 1. SMIC deserves a premium multiple of roughly 100 since China pushes for self-sufficiency in semiconductor supply. Rising research expenses in SMIC to develop next-generation production technology may be the biggest drag on profitability growth, further surging the stock price.