SMIC: 12-inch wafer production capacity approaching full load (24Q2 conference call minutes)

SMIC International (0981.HK/688981.SH) announced its 2024 second-quarter financial report on the evening of August 8, 2024, Beijing time (as of June 2024):

The following is a summary of the conference call for SMIC International's 2024 second-quarter financial report. For an interpretation of the financial report, please refer to " SMIC International: Soaring Against the Wind, Delivering Explosive Guidance "

I. $SMIC(00981.HK) Financial Highlights:

II. Detailed Content of SMIC International's Financial Report Conference Call

2.1. Key Points from Management's Statements:

1) Business Progress

① Demand Recovery

a. With the gradual recovery of mid-to-low-end consumer electronics, the willingness of various links in the industry chain to stock up and build inventory has increased, leading to new demand as some customers seize opportunities to enter the industry chain

b. Geopolitical factors leading to supply chain segmentation have prompted customers to advance shipments to cope with market changes, driving demand growth for the company

② Capacity Utilization

a. The utilization rate of 8-inch wafers has rebounded, and 12-inch capacity remains close to full, with newly added capacity rapidly put into production in the first half of the year

b. The comprehensive capacity utilization rate has increased to 85%, a 4-percentage-point increase compared to the previous period

③ Sales Revenue

a. In the second quarter, shipments exceeded 2.11 million pieces of 8-inch wafer equivalents, an 18% increase compared to the previous period, but the average selling price decreased by 8% due to changes in product mix

b. By region: China accounts for 80%, the U.S. for 16%, and Eurasia for 4%

c. By service type: Wafer revenue accounts for 93%, other revenue accounts for 7%; within wafer revenue, the proportion of 8-inch revenue has increased to 26%; 12-inch revenue accounts for 74%

d. By application: Smartphones account for 32%, computers and tablets for 13%, consumer electronics for 36%, internet and wearables for 11%, and industrial and automotive for 8%

④ $SMIC(688981.SH) Performance Outlook a. The revenue guidance for the third quarter is expected to increase by 13%-15% on a quarter-on-quarter basis, with a gross profit margin expected to be between 18%-20%, mainly due to accelerated localization demand, tight supply of 12-inch wafers, and improving prices.

b. The fourth quarter is usually the off-season, and it is expected that the full-year sales revenue growth rate will exceed the industry average, with the second half of the year expected to surpass the first half in sales revenue.

c. It is expected that by the end of the year, there will be an increase in production capacity of 60,000 12-inch wafers, which will bring higher added value through expanded production, further optimizing the product mix.

2) Financial Performance

① Sales Revenue and Gross Profit Margin

a. In the second quarter, sales revenue was $1.901 billion, an 8.6% increase quarter-on-quarter; the gross profit margin was 13.9%, a 0.2 percentage point increase quarter-on-quarter.

b. For the first half of the year, sales revenue was $3.651 billion, a 20.8% year-on-year increase; the gross profit margin was 13.8%, a 6.8 percentage point decrease year-on-year.

② Operating Profit and Cash Flow

a. In the second quarter, operating profit was $87 million, profit before interest, tax, depreciation, and amortization (EBITDA) was $1.056 billion, with an EBITDA margin of 55.5%.

b. Net profit attributable to the company was $165 million.

c. Net cash flow from operating activities in the second quarter was $19 million, net cash used in investing activities was an expenditure of $1.638 billion, and net cash generated from financing activities was an income of $46 million.

d. For the first half of the year, EBITDA was $1.943 billion, with an EBITDA margin of 53.2%.

e. Net profit attributable to the company was $236 million.

③ Asset and Liability Situation

a. At the end of the second quarter, the company's total assets were $47.4 billion, with cash and cash equivalents of $13 billion.

b. Total liabilities were $16.4 billion, with interest-bearing liabilities of $10.4 billion.

c. Total equity was $31 billion, with an interest-bearing debt-to-equity ratio of 33.7% and a net debt-to-equity ratio of -8.2%.

④ Outlook for the Third Quarter

a. The average unit price is expected to increase, mainly due to: 1) Accelerated localization demand caused by geopolitical influences, leading to a shortage of chip wafer capacity in several major market areas; 2) All expansions by the company this year are in 12-inch wafers, which have relatively higher added value, promoting further optimization of the product mix.

b. Sales revenue is expected to increase by 13%-15% on a quarter-on-quarter basis.

c. The gross profit margin is expected to be between 18%-20%.

2.2 Analyst Q&A

Q: Regarding the company's third-quarter guidance, how is the contribution of price and volume to the expected 13%-15% revenue growth? Additionally, you mentioned that geopolitical opportunities have brought some customers into the industry chain, could you provide more details on how these opportunities will impact sales growth in the third quarter, especially which products will contribute the most to growth?

A: Regarding the third-quarter guidance, we expect revenue to grow by 13%-15%. Specifically, in terms of the contribution of price and volume, at the end of the second quarter, we delivered a large number of 8-inch wafers ahead of schedule to meet customer demands, which means the shipment volume of 8-inch wafers will decrease in the third quarter, while the shipment volume of 12-inch wafers will increase Due to the increase in the proportion of 12-inch products, even if the price remains the same, the average price will rise. We expect a net increase of 60,000 pieces of 8-inch and 12-inch wafers by the end of the year, especially with the demand for 12-inch wafers outstripping supply. Therefore, these increments will be reflected in the third quarter, driving revenue growth. In terms of pricing, due to adjustments in the product mix, the shipment volume of lower-priced products has decreased, while the proportion of 12-inch products has increased, leading to a rise in unit price. Additionally, the increase in shipments of 12-inch wafers also compensates for the decrease in 8-inch wafers in the third quarter, keeping the overall shipment volume the same as the second quarter but with an increase in average unit price. These three factors, demand-driven price increases, increased proportion of 12-inch wafers, and the contribution of net increments, collectively contribute to the revenue growth.

Regarding the second question, the revenue growth mainly comes from the gradual recovery of the consumer market and the increase in inventory of mobile phone products. We divide the market into five major categories: mobile phones, computers and peripherals, consumer goods, internet and wearable devices, industrial and automotive. The consumer market, including games, toys, smart homes, etc., is currently the fastest-growing sector.

Q: What is your pricing strategy? We have noticed that in the past few quarters, different foundries have adopted different strategies in terms of pricing and capacity utilization. Some manufacturers choose to maintain prices but sacrifice capacity utilization, while others increase capacity utilization by lowering prices. In the current situation of rising demand, what strategy is SMIC adopting? What is the ideal gross margin and capacity utilization level for you?

A: SMIC's strategy is not to actively lower prices. Even when facing the same products, prices are steadily rising. We have indeed encountered situations where some manufacturers attract customers with low prices. When faced with such competition, if a customer's market share and product competitiveness are threatened, we will work with the customer to address this competition, but we will not actively lower prices. In the second quarter of this year, we have stabilized prices, and currently, they are only trending upwards, not downwards.

As our 12-inch products are in short supply, we will not lower prices to increase capacity utilization. However, if a product faces low-price competition in the market, we will support customers to face the competition and maintain market share and competitiveness.

Q: You have just detailed the demand situation, including the proactive inventory buildup, geopolitical demand, and the increase in localization demand. For the expectations of the fourth quarter, do you think there is a chance to continue the trend of the third quarter?

A: Currently, we see the situation in the fourth quarter as a combination of traditional patterns and new opportunities. Traditionally, due to the longer supply chain cycle, it takes about 6 months from wafer production to complete machine sales. Therefore, complete machine manufacturers usually set higher targets at the beginning of the year, stock up in advance to meet the demand for the whole year. However, by August or September, adjustments will be made based on actual consumption. Usually, the fourth quarter is a traditional off-season, and the revenue of wafer foundries tends to decrease because many manufacturers have sufficient inventory from the beginning of the year However, in the fourth quarter of this year, in addition to traditional seasonal factors, the demand for products such as smartphones, large-screen TVs, speakers, and IoT devices is also changing. We have received feedback from customers who are evaluating their inventory and considering whether to continue purchasing in the fourth quarter. Although this may affect revenue, the impact on capacity utilization is not significant.

Against this backdrop, we plan to allocate the additional market demand to the fourth quarter. Overall, despite the possibility of customers adjusting their purchase volumes in the fourth quarter, we remain cautiously optimistic about capacity utilization. Specific shipment volumes are still being negotiated with customers, but it is foreseeable that customers will adjust their receipts based on the high targets set at the beginning of the year, reducing the amount received. We have already received adjustment requests from some customers and are in discussions with them. The trend we are seeing is similar to our peers, with expectations that customers of products such as TVs, speakers, and smartphones will reduce their receipts in the fourth quarter.

Q: You just mentioned the product structure, especially the proportion of 12-inch in the second quarter may be relatively higher. Will this trend continue in the third and fourth quarters?

A: In the second quarter, the proportion of 8-inch wafers was actually higher because we moved up the production of 8-inch products scheduled for the third quarter to the second quarter to meet customer demand. Nevertheless, we also added a lot of new 12-inch capacity in the second quarter. Although the total output of 8-inch did not increase, its proportion in overall capacity still rose. By the third quarter, the shipment volume of 8-inch will decrease, while the shipment volume of 12-inch will increase, coupled with the steady rise in the price of 12-inch products, so our gross margin and average selling price (ASP) will increase. We believe this trend will continue into the fourth quarter.

Q: Regarding the 28-nanometer and 40/45-nanometer processes, you previously mentioned that the company needs to build a diversified platform at each node. How is the progress of building the 40/45-nanometer platform? Also, could you provide an update on the current status of 28-nanometer and the focus of the next stage of construction?

A: SMIC is currently working on mature technologies such as 40-nanometer and 28-nanometer, which have been around for over a decade. 40-nanometer started mass production about 12 years ago, while 28-nanometer started mass production over a decade ago or even earlier. When we entered these nodes, the industry had shifted from initial high-performance logic applications (such as AP in smartphones, CPU, GPU in computers) to a wider range of applications.

SMIC's strategy is to build a diversified technology platform at these mature nodes, covering various areas from standard logic to RF analog, ultra-low power, embedded storage (such as MCU), optoelectronics (such as CMOS image sensors), high-voltage drive, and more. The broad applicability of these applications requires us to produce a variety of products in the same factory and continuously iterate and optimize technologies to improve yield and reduce costs.

Specifically, after years of effort, the 40-nanometer platform has now entered the mass production stage, covering a variety of applications. As for 28-nanometer, due to SMIC's relatively late entry, the capacity is relatively limited, so it is still being continuously improved. We are working hard to develop the 28-nanometer platform into a complete technology platform, covering standard logic, RF, ultra-low power, high-voltage drive, MCU, and meeting different requirements for consumer, industrial, and automotive grades Currently, the 28-nanometer platform is already full, and we are gradually improving it into a complete technical platform according to customer needs, similar to what we have achieved on the 40-nanometer platform.

Q: Since the beginning of this year, we have observed some adjustments in the prices of certain low-voltage power products and mid-to-low-end analog chip products in the market. How do you view the driving force behind this trend, as well as the sustainability of this price increase?

A: In the BCD and analog chip fields, we have indeed seen an increase in demand, with more capacity entering the market, including some 8-inch capacity and idle capacity from memory production being transferred to this field. We clearly see a trend of separation between the high-end and mid-to-low-end markets. Currently, the high-end market is still mainly dominated by SMIC, while the mid-to-low-end market is gradually shifting towards other competitors.

In terms of applications, there is demand for low-voltage power management chips almost everywhere, especially in the high-end sector, where the demand for small-area, high-efficiency chips is more significant. For example, when you need to provide power for a GPU or DRAM module, a 1-volt power chip can be as small as 1mm by 1mm in size, allowing for very compact placement on the circuit board. Currently, there is a very high demand for high-end power management chips, and supply falls short. In the mid-to-low-end market, various applications require power management, especially with the popularization of fast charging technology, leading to a significant increase in demand for high-voltage BCD chips. Overall, the demand for mid-to-low-end analog chips remains very high, especially for products that can provide power management above 40 volts, which are still in short supply.

Q: You mentioned changes in demand and product innovation. My question is, are the factors behind the price changes related to the previous clearance on the supply side? When financing was relatively easy, many companies focused more on financial profits and neglected industrial profits, leading to intense price competition. Now that financing has become more difficult, have there been some proactive price increases for self-preservation? If so, would these price increases lead to relatively lower sustainability in price hikes? Is this understanding correct?

A: Price changes mainly depend on the supply-demand relationship and capacity. As mentioned earlier, in the analog chip field, especially in high-end products, a situation of supply shortage is inevitable, leading to price increases. If a large amount of capacity is invested in high-end products, the relative shortage of supply for mid-to-low-end products will also result in price increases.

From the customers we have interacted with, we sense a more proactive attitude. They may have originally focused only on the mass market, but now, due to changes in the supply chain or geopolitical factors, they are forced to offer higher-end or better quality products to meet more critical market demands. These improvements allow them to command higher prices in the market.

Q: Since the third quarter of last year, the recovery performance of the Android industry chain has exceeded expectations, causing some concerns in the market about the sustainability of this trend, fearing that it may just be short-term restocking behavior. However, several consulting firms are more optimistic about semiconductor growth expectations for this year and next year However, in the case of tight production capacity, customers have low order visibility and more urgent orders, which seems to present a contradiction between business activity and order visibility. Could you further interpret this phenomenon?

A: This is indeed a question worth exploring. After September 2022, the Chinese market quickly responded, realizing that inventory levels were high, leading many companies to announce production cuts. Throughout 2023, the revenue of SMIC also decreased, with orders for both new and old products decreasing in the market. Moving into 2024, the market restocked in the first half of the year to bring inventory levels back to a safe level, typically considered to be around 80 days of sales volume. Restocking in the first half accounted for about 15%-20% of the annual orders, but this will not lead to sustained growth. After restocking is completed, future order volumes will mainly depend on actual market demand rather than restocking needs. Therefore, order volumes in the fourth quarter may be lower than in the second and third quarters.

Currently, demand in markets such as mobile phones, computers, and peripheral devices is gradually recovering, with no further decline in the industry as a whole. The automotive and industrial markets have not fully recovered yet, but there is no significant downturn either. We expect order volumes to gradually reflect actual market demand rather than restocking needs. SMIC will continue to monitor market changes, seize new opportunities for demand growth, adjust capacity allocation to meet future incremental demand.

Q: Last year, it was mentioned at the annual performance meeting that SMIC had a plan to expand production by 340,000 wafers. What is the progress now?

A: Regarding this issue, SMIC has announced several large-scale infrastructure plans in the past few years, involving the construction of new factories in multiple new plant areas, the purchase of new equipment, and the addition of new capacity. The specific timetables and capacity scales of these projects have been disclosed in announcements. Currently, we are accelerating the construction of capacity to ensure that the targets are completed as early as possible. By the end of this year, we will increase 12-inch capacity by about 60,000 wafers. This exceeds our original expectation of increasing by 30,000 to 50,000 wafers per year. Therefore, our expansion plan is progressing smoothly, and at a faster pace than originally planned, to meet the continuous growth in customer demand.

Q: Regarding the industry trends mentioned by TSMC at its conference, especially the integration of packaging testing with chip manufacturing becoming an industry trend, how does SMIC position itself in this market? What is your view on market growth for the entire industry?

A: 93% of SMIC's revenue comes from its own wafer manufacturing, with the remaining 7% involving photolithography services and outsourcing services such as packaging testing for customers. We have always worked closely with customers to decide whether to integrate packaging testing and other processes internally based on customer needs. Currently, we mainly use external resources to help customers with packaging testing to meet their flexibility needs. SMIC has also previously established joint ventures with external packaging testing companies to provide these services, and we have made related investments, serving as a major shareholder. Although we have not yet decided to fully internalize these services, we closely monitor customer needs for the next 3 to 5 years and will make corresponding arrangements based on their strategic requirements Overall, SMIC's strategy has always revolved around customer needs. While enhancing our own competitiveness, we have maintained close cooperation with customers, respecting and listening to their needs to ensure that we can provide services and products that best meet customer expectations.

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