Rising Geopolitical Risks And Overspending Will Erode Margins

Key Takeaways

• Geopolitical tensions and technology restrictions hinder SMIC's innovation and growth, while global clients reduce reliance on Chinese foundries, shrinking its market potential.
  
• High capital spending, cash flow pressures, and increasing competition threaten profitability, likely confining SMIC to less advanced manufacturing segments.
  
• Ongoing capacity expansion, efficiency gains, and diversified end-market growth position SMIC for sustained top-line growth and improved margins despite short-term pricing fluctuations.

Catalysts

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

• As global supply chains increasingly diversify away from single-source regions, multinational clients are expected to limit reliance on Chinese foundries, reducing SMIC's addressable market and putting long-term revenue growth at risk.
  
• Rising geopolitical tensions, especially persistent Western technology restrictions, threaten SMIC's ability to access advanced manufacturing equipment, undermining innovation and capping both revenue and net margin expansion for years to come.
  
• Ongoing capital expenditure-over $7.5 billion a year-and negative free cash flow point to a future in which SMIC's earnings are weighed down by relentless depreciation and capital intensity, eroding return on invested capital and limiting shareholder value creation.
  
• Intensifying competition and rapid technological advances by global peers will likely widen the technology gap, relegating SMIC to mature-node manufacturing and causing average selling prices and gross margins to steadily deteriorate.
  
• Seasonally front-loaded demand, inventory corrections in major end markets, and oversupply-particularly in segments like PCs, tablets, and smartphones-raise the risk of weak utilization, further ASP declines, and compressing profitability through 2025 and beyond.

Semiconductor Manufacturing International Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Semiconductor Manufacturing International compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Semiconductor Manufacturing International's revenue will grow by 8.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 7.1% today to 5.2% in 3 years time.
• The bearish analysts expect earnings to reach $573.6 million (and earnings per share of $0.07) by about July 2028, down from $609.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 47.4x on those 2028 earnings, down from 89.1x today. This future PE is greater than the current PE for the US Semiconductor industry at 26.4x.
• Analysts expect the number of shares outstanding to grow by 0.29% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.34%, as per the Simply Wall St company report.

Semiconductor Manufacturing International Future Earnings Per Share Growth

Risks

• SMIC is continuing a steady pace of capacity expansion, having announced ongoing multi-year projects in Beijing, Shenzhen, Lingang, and Tianjin since 2020, and is maintaining capital expenditures of about $7.5 billion per year; this sustained investment in production assets indicates the company is poised for increased future output and revenue growth as these projects ramp to full utilization.
  
• The company's manufacturing capacity utilization across both 8-inch and 12-inch fabs remains high, with rates consistently around 90 percent even after the addition of new capacity, suggesting robust demand and operating leverage that should help support future revenue and potentially stable or improving margins.
  
• There is evidence that SMIC is capturing greater market share in automotive, industrial, and specialty memory applications, with Q1 seeing a more than 20 percent sequential revenue increase in industrial and automotive segments and strong growth across specialty platforms, supporting a secular trend toward long-term multi-vertical chip demand and top-line growth.
  
• Despite current short-term ASP declines largely tied to one-off production disruptions and a temporary learning curve in equipment/process improvements, management affirms that ASP strategy is based on sustainable, long-term client agreements rather than aggressive price-cutting, and expects pricing to stabilize as process issues are resolved, which could preserve average selling prices and protect gross margins over the medium term.
  
• The company is undergoing notable operational efficiency gains from automation and digitalization in manufacturing, driving increased revenue per employee and holding headcount steady as output climbs; these improvements bolster cost competitiveness and position SMIC to expand margins and earnings as new capacity comes online in the longer term.

Valuation

• The assumed bearish price target for Semiconductor Manufacturing International is HK$19.21, which represents two standard deviations below the consensus price target of HK$47.58. This valuation is based on what can be assumed as the expectations of Semiconductor Manufacturing International's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$65.0, and the most bearish reporting a price target of just HK$14.13.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $11.0 billion, earnings will come to $573.6 million, and it would be trading on a PE ratio of 47.4x, assuming you use a discount rate of 11.3%.
  
• Given the current share price of HK$53.35, the bearish analyst price target of HK$19.21 is 177.7% lower.
  
• 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.