Sanction Fears Hit SMIC Shares Hard, Plunges over 20%

Semiconductor Manufacturing International Corporation (SMIC), a partially state-owned publicly listed semiconductor foundry company, and the largest in China, plunged over 20% on Monday in response to reports that the U.S. government is exploring whether to add the chip makers to a trade blacklist.

In response, SMIC on its website said they have no relationship with the Chinese military and any assumptions of the Company’s ties with the Chinese military are untrue statements and false accusations. China’s top chipmaker said they are in complete shock and perplexity to the news.

“We are not surprised by this and expect more export restrictions on USSPE and EDA to China, with the focus going beyond Huawei. Besides SMIC, AMAT and LRCX will also suffer, as 30% of their revs come from China,” said Edison Lee, equity analyst at Jefferies.

“Should the U.S. export ban on SMIC materialize, it will signal an escalated attack by the U.S. on China’s semi industry, and more Chinese companies will likely be included. This is negative not only for China’s semi industry (eg, SMIC/HH is trading at 2-3 sd above LT avg multiples) but also for SPE makers globally, as China could account for 24% of global SPE procurement in 2020.  We estimate that China’s semi plants in the pipeline would cost equipment capex of US$36 billion,” Lee added.

SMIC’s shares plunged over 20% to HKD 18.78 on Monday. However, the stock is up about 60% so far this year.

SMIC stock forecast and analyst views

Morgan Stanley gave a target price of HKD 25.0 with a high of HKD 39.3 under a bull-case scenario and HKD 7.1 under the worst-case scenario.

“SMIC appears well-positioned for Chinese semi demand, thanks to its location advantage and support from the government and Chinese chip companies. However, we think its profitability is unlikely to improve given its aggressive spending on capacity expansion,” said Charlie Chan, equity analyst at Morgan Stanley in August.

“SMIC’s strategic position in China with its advanced node businesses should help keep its Chinese customers, but we think it could face challenges climbing the learning curve without a strong advanced nodes partner such as HiSilicon. We believe the current valuation is sustainable given the company’s leading position among Chinese foundries,” he added.

Upside and Downside risks

Upside: 1) Global and Chinese semi demand strengthens. 2) Pricing competition eases, helping margins. 3)  Technology development breakthroughs come faster than expected, shortening its transition period. 4) Better-than-expected utilization rate, product mix, and ASP – highlighted Morgan Stanley.

Downside: 1) Global and Chinese semi demand weakens. 2) Pricing competition intensifies, deteriorating margins. 3) Worse-than-expected utilization rate, product mix, and ASP trend.

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