Geopolitical Factors and the Gray Rhino Effect: Challenges Facing SMIC

Zhao Haijun, co-chief executive at Semiconductor Manufacturing International Corp. (SMIC), recently expressed concern about the impact of geopolitical factors on the company's future development. Speaking as SMIC's shares experienced a 6% decline in Hong Kong, Zhao highlighted the duplication of construction and uncertainty within the supply chain as significant obstacles.

Plunging Profits and Weak Sales: SMIC's Third-Quarter Performance

SMIC, the largest China foundry specializing in chip manufacturing for other companies, reported a sharp decline in net profit for the third quarter. The company's profits fell by 76.7% to $93.9 million, well below the analysts' expectations of $173.9 million. Furthermore, SMIC's revenue totaled $1.621 billion, a sequential increase of 3.9%, but a year-over-year decrease of 15%.

Challenging Margins and Expectations for the Fourth Quarter

SMIC's third-quarter performance also revealed a decline in gross margins. While the second quarter boasted a margin of 20.3%, this decreased to 19.8% in the following quarter. Looking ahead to the fourth quarter, SMIC anticipates a 1-3% increase in revenue. However, it acknowledges that gross margins will face additional strain due to continuous depreciation pressure, projecting a range of 16-18%.

Capital Expenditures and Future Outlook

To confront these challenges head-on, SMIC plans to allocate approximately $7.5 billion towards capital expenditures. This investment aims to address issues within the supply chain and bolster the company's competitive positioning. While SMIC remains cautious yet attentive to market changes, it remains fully committed to exploring various strategies and paths for sustained growth.

The Gray Rhino Effect: Implications and Ignored Threats

During an analyst conference call, Zhao Haijun referred to the "gray rhino effect," a term used to describe a seemingly obvious yet neglected threat. He emphasized that all segments of the industry supply chain are currently grappling with this issue, demonstrating the need for a cautious approach and persistent efforts.

Key Challenges: Weak Demand and U.S. Sanctions

Like many other chip manufacturers, SMIC has been confronting challenges due to weak global demand caused by a slowing economy. This, coupled with ongoing supply-chain issues, has added further strain to the company's performance. SMIC's operations have also been impacted by U.S. sanctions since 2020.

As the industry faces ongoing geopolitical factors and supply chain uncertainties, SMIC recognizes the importance of carefully navigating these obstacles. By maintaining a vigilant stance and seizing opportunities for growth, SMIC aims to overcome these challenges and emerge stronger in the long run.

SMIC's Overseas Destocking of Chips: A Challenging Trend Yet an Opportunity for China Sales

In a recent development, Haijin, a representative from SMIC, revealed that the start of overseas destocking of chips, particularly for mobile phones and consumer-related integrated circuit chips, occurred later compared to the domestic market. This ongoing trend presents difficulties; however, it has also presented an opportunity for China sales to contribute significantly to the company's overall revenue.

Notably, in the third quarter, China accounted for 84% of SMIC's revenue, a notable increase from about 80% in the previous quarter. This surge reflects the positive impact of the destocking phenomenon.

Haijin further stated that the market has seemingly "stabilized," with the demand for mature foundries like SMIC's expected to experience growth in the upcoming year. This growth can be attributed to the decrease in inventories.

Despite these positive observations, Haijin expressed that the market still lacks the necessary drivers and momentum for significant growth. He emphasized that a recovery within the global macroeconomics is crucial and fundamental for the upcoming year.

Interestingly, SMIC's recent financial results have left some analysts puzzled. For instance, Jenny Hardy, a portfolio manager at GP Bullhound, noted that SMIC should have benefited from manufacturing Huawei's 7-nanometer Mate Pro chip, which has reportedly been selling very well. However, the company's profitability has declined, and sales were down by 15% compared to the previous year.

Hardy questioned the profitability of SMIC's manufacturing process for 7nm chips and whether Huawei is shouldering the costs. She also expressed surprise at the lackluster sales, which was contradictory to what she had heard from other sources. She even speculated that SMIC may be losing its share among international clients due to potential political sensitivities.

In conclusion, although there are challenges posed by the overseas destocking of chips, SMIC has managed to capitalize on this trend by increasing its sales in China. Looking ahead, the company anticipates growth in the coming year but acknowledges the need for a recovery in global macroeconomics to drive significant market expansion.