Capacity Expansion Will Pressure Margins But Tap Into Growing Automotive Demand

Key Takeaways

• Aggressive capacity expansion and localization efforts boost revenue but pressure gross margins due to high depreciation and surplus capacity.
  
• Maintaining market share through pricing strategies may limit revenue growth, with intensified competition and fluctuating demand impacting margins.
  
• Revenue and margin growth, coupled with strong cash reserves, position SMIC for sustained financial resilience and potential expansion into the automotive market.

Catalysts

An investment holding company, engages in the manufacture, testing, and sale of integrated circuits in the United States, China, and Eurasia.

• The company's accelerated pace of capacity expansion and new product verification have been key drivers of revenue growth, but they also increase depreciation, impacting gross margins negatively.
  
• The ongoing high capital expenditure of approximately $7.33 billion is expected to continue, which may strain net margins due to increased depreciation costs as new capacity becomes operational.
  
• Geopolitical pressures have necessitated increased investments to localize supply chains, boosting revenue but leading to structurally surplus capacity, which could pressure pricing and gross margins.
  
• Competitive dynamics in the industry have intensified, with the company maintaining market share through consistent pricing strategies, which may limit the potential for revenue growth as the company faces structural overcapacity issues.
  
• The strategic focus on maintaining market share might lead to price competition, further compressing gross margins, especially in a market with fluctuating demand and surges in customer restocking requirements.

Semiconductor Manufacturing International Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Semiconductor Manufacturing International's revenue will grow by 17.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 7.5% today to 9.5% in 3 years time.
• Analysts expect earnings to reach $1.1 billion (and earnings per share of $0.14) by about March 2028, up from $559.8 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $1.6 billion in earnings, and the most bearish expecting $559 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 50.7x on those 2028 earnings, down from 93.6x today. This future PE is greater than the current PE for the US Semiconductor industry at 19.7x.
• Analysts expect the number of shares outstanding to grow by 0.16% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.02%, as per the Simply Wall St company report.

Semiconductor Manufacturing International Future Earnings Per Share Growth

Risks

• Revenue increased by 27% year-over-year in 2024, driven by a recovery in the overall semiconductor market and increased demand for localized manufacturing, suggesting strong future revenue prospects.
  
• Gross margin improvements in the fourth quarter and anticipated revenue growth higher than the industry average in 2025 indicate potential for stable or increasing earnings.
  
• Robust cash flow generated from operating activities and a strong balance sheet, with significant cash reserves compared to debt, show financial resilience that could support continued investment and potentially enhance future profitability.
  
• Expansion of capacity and verification of new products and platforms indicate that SMIC is well-positioned to capitalize on increased demand, supporting future revenue and earnings growth.
  
• The focus on automotive-grade certifications and the expected growth in the automotive market could lead to diversified and increased revenue streams.

Valuation

• The analysts have a consensus price target of HK$42.18 for Semiconductor Manufacturing International based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$67.0, and the most bearish reporting a price target of just HK$13.99.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $12.0 billion, earnings will come to $1.1 billion, and it would be trading on a PE ratio of 50.7x, assuming you use a discount rate of 10.0%.
• Given the current share price of HK$51.05, the analyst price target of HK$42.18 is 21.0% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.