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January 19, 2017
COMPANY UPDATE SMIC (0981.HK)
Sell Equity Research
Higher demand and EPS, but depreciation skews the story; Sell
What's changed
Historically, second-tier foundries have always run at lower utilization than
industry leader TSMC, but SMIC has kept utilization above 97% since 2Q15
and consistently above that of TSMC, likely due to a desire among its
customers to support the Chinese government’s efforts to strengthen the
domestic foundry industry. We expect SMIC to maintain 97% average
utilization and surpass its target of a 20% revenue CAGR in 2016-2019. We
also expect SMIC’s R&D grants to sustain and rise from US$34mn in 2015
to US$65mn and US$95mn (19% and 20% of earnings) in 2016E and 2019E
respectively, referencing the industry’s development path in Taiwan.
Implications
We have raised our assumptions for utilization and government grants,
which increases our 2016E-2018E EPS by 15%/146%/84%. However, we
note the company’s 7-year depreciation policy (vs. peers’ 5 years), which
we believe leads to SMIC’s high margins and ROE relative to peers despite
its lower revenue/net PP&E ratio. Even using 7-year depreciation, our
2017E-2018E depreciation estimates for SMIC are 37% above consensus.
As a result, even as we turn more positive on SMIC’s demand and R&D
grants outlook, we stay cautious on its returns and valuation. Additionally,
to offset the differences in depreciation policies, we change our valuation
methodology from P/B-ROE to EV/GCI-CROCI/WACC, which is based on
gross assets.
Valuation
Our 12-month target price rises to HK$8.40 from HK$7.40 (ADR to US$5.40
from US$4.70) after adjusting for December’s reverse stock split and
changing our valuation basis from P/B to EV/DACF, which is derived from
EV/GCI-CROCI/WACC and factors in SMIC’s superior growth in 2016-2019E.
Our new target price implies a NTM P/B of 1.19X (above UMC’s 0.61X and
Hua Hong’s 0.74X) and 24% downside potential; we maintain Sell.
Key risks
Higher-than-expected R&D grants and stock purchases by gov’t entities.
INVESTMENT LIST MEMBERSHIP
Asia Pacific Sell List
Coverage View: Neutral
Donald Lu, Ph.D +86(10)6627-3123 [email protected] Beijing Gao Hua Securities Company Limited Goldman Sachs does and seeks to do business with companies
covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.
The Goldman Sachs Group, Inc. Global Investment Research
Growth
Returns *
Multiple
Volatility Volatility
Multiple
Returns *
Growth
Investment Profile
Low High
Percentile 20th 40th 60th 80th 100th
* Returns = Return on Capital For a complete description of the investment
profile measures please refer to the
disclosure section of this document.
SMIC (0981.HK)
Asia Pacific Technology Peer Group Average
Key data Current
Price (HK$) 10.88
12 month price target (HK$) 8.40
SMI Price ($) 7.05
SMI 12 month price target ($) 5.40
Market cap (HK$ mn / US$ mn) 39,931.2 / 5,148.4
Foreign ownership (%) --
12/15 12/16E 12/17E 12/18E
EPS ($) New 0.07 0.09 0.09 0.10
EPS revision (%) 0.0 15.1 145.6 84.3
EPS growth (%) 53.4 36.7 1.3 8.8
EPS (dil) ($) New 0.06 0.08 0.08 0.08
P/E (X) 15.1 15.8 15.6 14.3
P/B (X) 1.0 1.4 1.3 1.2
EV/EBITDA (X) 6.3 7.6 7.1 6.5
Dividend yield (%) 0.0 0.0 0.0 0.0
ROE (%) 7.6 9.5 8.7 8.7
CROCI (%) 4.6 8.3 8.1 8.5
Price performance chart
7,500
8,000
8,500
9,000
9,500
10,000
10,500
11,000
11,500
5
6
7
8
9
10
11
12
13
Jan-16 Apr-16 Jul-16 Nov-16
SMIC (L) Hang Seng China Ent. Index (R)
Share price performance (%) 3 month 6 month 12 monthAbsolute 13.3 70.0 57.7
Rel. to Hang Seng China Ent. Index 12.4 57.7 30.9
Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 1/18/2017 close.
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 2
SMIC: Summary Financials
Analyst Contributors
Donald Lu, Ph.D
Profit model ($ mn) 12/15 12/16E 12/17E 12/18E Balance sheet ($ mn) 12/15 12/16E 12/17E 12/18E
Total revenue 2,236.4 2,910.2 3,622.1 4,339.4 Cash & equivalents 1,005.2 1,813.9 1,108.8 364.1
Cost of goods sold (1,553.8) (2,073.8) (2,639.4) (3,134.6) Accounts receivable 499.8 664.3 779.7 949.6
SG&A (255.1) (183.2) (259.3) (303.9) Inventory 387.3 513.3 625.8 736.2
R&D (237.2) (309.4) (373.1) (464.6) Other current assets 697.7 723.4 723.4 723.4
Other operating profit/(expense) 31.6 12.5 14.8 14.8 Total current assets 2,590.1 3,714.8 3,237.7 2,773.3
ESO expense -- -- -- -- Net PP&E 3,903.8 5,882.7 7,297.5 8,510.4
EBITDA 745.6 1,092.7 1,350.3 1,638.0 Net intangibles 224.3 225.1 225.1 225.1
Depreciation & amortization (523.5) (736.3) (985.2) (1,187.0) Total investments 199.0 263.2 263.2 263.2
EBIT 222.0 356.4 365.1 451.0 Other long-term assets 198.2 229.7 229.7 229.7
Interest income 5.2 9.7 12.0 6.6 Total assets 7,115.3 10,315.6 11,253.2 12,001.8
Interest expense (12.2) (18.9) (20.4) (20.4)
Income/(loss) from uncons. subs. (13.4) (12.4) 0.0 0.0 Accounts payable 1,047.8 1,208.0 1,251.9 1,251.8
Others 29.3 (10.2) 0.0 0.0 Short-term debt 113.1 156.6 156.6 156.6
Pretax profits 230.9 324.6 356.7 437.3 Other current liabilities 213.7 282.7 282.7 282.7
Income tax (8.5) (2.5) (3.0) (3.6) Total current liabilities 1,374.6 1,647.3 1,691.2 1,691.2
Minorities 31.1 52.9 26.6 (19.7) Long-term debt 1,301.9 2,752.1 2,752.1 2,752.1
Net income pre-preferred dividends 253.4 375.0 380.3 414.0 Other long-term liabilities 248.7 401.9 401.9 401.9
Preferred dividends 0.0 0.0 0.0 0.0 Total long-term liabilities 1,550.5 3,154.0 3,154.0 3,154.0
Net income (pre-exceptionals) 253.4 375.0 380.3 414.0 Total liabilities 2,925.1 4,801.3 4,845.2 4,845.1
Post-tax exceptionals 0.0 0.0 0.0 0.0
Net income 253.4 375.0 380.3 414.0 Preferred shares 0.0 0.0 0.0 0.0
Total common equity 3,729.9 4,169.0 4,549.4 4,963.4
EPS (basic, pre-except) ($) 0.07 0.09 0.09 0.10 Minority interest 460.4 1,345.2 1,858.6 2,193.3
EPS (basic, post-except) ($) 0.07 0.09 0.09 0.10
EPS (diluted, post-except) ($) 0.06 0.08 0.08 0.08 Total liabilities & equity 7,115.3 10,315.6 11,253.2 12,001.8
EPS excl. ESO expense (basic) ($) -- -- -- --
EPS excl. ESO expense (dil.) ($) -- -- -- -- BVPS ($) 0.96 0.99 1.08 1.18
DPS ($) 0.00 0.00 0.00 0.00
Dividend payout ratio (%) 0.0 0.0 0.0 0.0
Free cash flow yield (%) (13.1) (22.7) (16.0) (13.1)
Ratios 12/15 12/16E 12/17E 12/18E
Growth & margins (%) 12/15 12/16E 12/17E 12/18E CROCI (%) 4.6 8.3 8.1 8.5
Sales growth 13.5 30.1 24.5 19.8 ROE (%) 7.6 9.5 8.7 8.7
EBITDA growth 9.7 46.6 23.6 21.3 ROA (%) 3.9 4.3 3.5 3.6
EBIT growth 70.5 60.5 2.4 23.6 ROACE (%) 5.3 5.9 4.9 5.0
Net income growth 68.6 48.0 1.4 8.8 Inventory days 82.6 79.3 78.8 79.3
EPS growth 53.4 36.7 1.3 8.8 Receivables days 78.0 73.0 72.8 72.7
Gross margin 30.5 28.7 27.1 27.8 Payable days 216.4 198.5 170.1 145.8
EBITDA margin 33.3 37.5 37.3 37.7 Net debt/equity (%) 9.8 19.9 28.1 35.6
EBIT margin 9.9 12.2 10.1 10.4 Interest cover - EBIT (X) 31.6 38.9 43.6 32.8
Cash flow statement ($ mn) 12/15 12/16E 12/17E 12/18E Valuation 12/15 12/16E 12/17E 12/18E
Net income pre-preferred dividends 253.4 375.0 380.3 414.0
D&A add-back 523.5 736.3 985.2 1,187.0 P/E (analyst) (X) 15.1 15.8 15.6 14.3
Minorities interests add-back (31.1) (52.9) (26.6) 19.7 P/B (X) 1.0 1.4 1.3 1.2
Net (inc)/dec working capital 138.7 (130.1) (184.1) (280.4) EV/EBITDA (X) 6.3 7.6 7.1 6.5
Other operating cash flow (215.3) 73.5 0.0 0.0 EV/GCI (X) 0.4 0.5 0.5 0.5
Cash flow from operations 669.2 1,001.7 1,154.9 1,340.3 Dividend yield (%) 0.0 0.0 0.0 0.0
Capital expenditures (1,230.8) (2,653.5) (2,400.0) (2,400.0)
Acquisitions 0.0 (41.2) 0.0 0.0
Divestitures 49.2 0.0 0.0 0.0
Others 392.0 (6.3) 0.0 0.0
Cash flow from investments (789.6) (2,701.0) (2,400.0) (2,400.0)
Dividends paid (common & pref) 0.0 0.0 0.0 0.0
Inc/(dec) in debt (112.6) 1,596.2 0.0 0.0
Common stock issuance (repurchase) 517.6 6.6 0.0 0.0
Other financing cash flows 117.5 905.2 540.0 315.0
Cash flow from financing 522.5 2,508.0 540.0 315.0 Note: Last actual year may include reported and estimated data.
Total cash flow 402.2 808.7 (705.1) (744.7) Source: Company data, Goldman Sachs Research estimates.
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 3
We underestimated demand and R&D grants at SMIC
SMIC has had higher utilization than TSMC since 2Q15
Historically, second-tier foundries have always run at lower utilization than industry leader
TSMC. This is because TSMC can leverage its leading-edge technology to entice customers
to fill its capacity during periods of demand weakness. Contrary to this historical trend,
SMIC has maintained utilization above 97% since 2Q15, well above that of TSMC (Exhibit 1).
Furthermore, SMIC expects its wafer shipments to increase qoq in 1Q17, while we expect
shipments at TSMC and UMC to decline seasonally. SMIC has said its 40nm and 65nm
supply is constrained. As our channel checks indicate several customers including Hi-Silicon
are moving 40nm wafers to SMIC, we expect SMIC should continue to gain market share at
40nm (Exhibit 3). According to Digitimes, Qualcomm and Hi-Silicon have utilized 60%-70%
of SMIC’s 8” capacity. Qualcomm and Leadcore are SMIC’s 28nm customers, but we
believe SMIC’s 28nm is PolySiON and has inferior margin than its 40nm.
How did SMIC achieve this unprecedented high utilization and market share gain for a
second-tier foundry? Technology is not the answer. In 2016, the technology gap between
TSMC and SMIC has widened as TSMC enters 10nm mass production, and SMIC is still
struggling with its 28nm PolySiON (Exhibit 4). Pricing is also not the answer. We believe
SMIC has not cut its 40nm pricing in view of its steady EBITDA margin. We attribute SMIC’s
outperformance to its customers’ strong desire to source from SMIC in order to support the
government’s efforts to develop the foundry industry in China.
We now assume SMIC’s high revenue growth at high utilization is sustainable, but we note
that a risk to this assumption is competition from TSMC and UMC, which are ramping up
their China fabs. According to Digitimes, Spreadtrum is the first 40nm customer at UMC’s
fab in Xiamen. We expect TSMC to begin to manufacture 16nm wafers in Nanjing in 2018,
well ahead of SMIC. We do not yet know if the central government will count TSMC and
UMC’s China fabs as China foundry, but we believe the Xiamen and Nanjing local
governments should fully support UMC and TSMC’s China operations, respectively.
Exhibit 1: SMIC’s utilization has trended above 75% and surpassed TSMC’s in 2Q15
Comparison of utilization among TSMC, UMC, and SMIC
Source: Company data, Gao Hua Securities Research
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E
TSMC UMC SMIC
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 4
Exhibit 2: Foundry 40nm market is relatively flattish
40nm revenues of TSMC, UMC, and SMIC (US$ mn)
Exhibit 3: SMIC has gained significant 40nm market share
40nm market share among TSMC, UMC, and SMIC
Source: Company data
Source: Company data
Exhibit 4: The technology gap between TSMC and SMIC is still widening Time gap when the node represented 1.4% of total revenues
Source: Company data
Government R&D grants are recurring and increasing
SMIC has received grants from the government for its R&D in leading-edge semiconductor
technology. Since the cost of R&D has escalated with each node of Moore’s Law, the level
of government R&D grants has increased from US$34mn in 2015 to US$65mn, or 19% of
total net income, in 2016. We expect grants to reach US$95mn in 2019 as R&D intensity
increases with each node. SMIC’s next technology is 16nm, and the government’s plan
stipulates 20nm mass production by 2020. We expect the government to support SMIC
because it is the only Chinese company carrying out 16nm R&D. We note that this kind of
government support was common in Taiwan, Korea, and Japan in early days of their
respective semiconductor industry. For example, Taiwan offered substantial tax rebate for
R&D and capex until 2011 when TSMC’s revenue reached $13.8bn, well above SMIC’s
2016E revenue of $2.9bn. In fact, we believe the main risk to our Sell rating is the potential
for a large amount of R&D being granted to SMIC in 2017-2019. If the government R&D
grants surpass our current expected level by a large margin, we expect the additional part
could be reflected as upside in SMIC’s operating profit and net profit, which would make us
more constructive on the shares.
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TSMC UMC SMIC
TSMC UMC SMICTSMC vs.
SMIC
UMC vs.
SMIC
40nm 3Q09 2Q10 4Q12 12Q 9Q
28nm 4Q11 2Q14 3Q16 18Q 8Q
Over 1.4%
revenue
Technology progression
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 5
Exhibit 5: We expect government R&D grants to increase at SMIC Government R&D grants and as % of total net income at SMIC
Source: Company data, Gao Hua Securities Research
SMIC reports higher ROE but lower PP&E efficiency than UMC
A comparison of profitability reveals an intriguing discrepancy between SMIC and UMC
(Exhibits 6 and 12). For 2016E, SMIC has a much lower revenue/net PP&E ratio than UMC,
indicating SMIC’s asset efficiency is lower than that of UMC (Exhibit 12), partially due to
UMC’s fully depreciated fab. However, SMIC reports much higher net margin and ROE than
UMC. SMIC’s superior utilization and high R&D grants discussed above explain a big part
of this discrepancy, but these effects should be reflected in EBITDA, and we note that UMC
still has a higher EBITDA margin than SMIC. We believe SMIC’s low depreciation/revenue
ratio is another major contributor to this discrepancy.
In Exhibits 7-9, we compare the depreciation/PP&E ratios for TSMC, UMC and SMIC.
SMIC’s depreciation level is clearly well below that of TSMC and UMC. We attribute this
difference to SMIC’s longer 12” equipment depreciation of 7 years than TSMC and UMC’s
5 years. The merits of 5-year vs. 7-year depreciation are debatable because the production
life of a fab is much longer than 7 years while wafer prices decline every year, but the pace
of decline decelerates over time. We do not hold a strong view on which depreciation
period is most appropriate, but do believe that we need to take into account the differences
in depreciation policies when comparing ROE and book value between SMIC and its peers.
We note SMIC’s depreciation is about 10% below its 7-year average capex (Exhibit 10) and
assume the same trend in 2017E-2019E. Our depreciation assumptions are well above
consensus.
On a free cash flow basis, SMIC’s consolidated business has accumulated a US$4bn
outflow since its IPO in 2004 (Exhibit 11). However, SMIC has said it will use pure debt to
finance growth going forward, because the gap in cash flow should narrow, and its Beijing
government JV partner should contribute an additional US$990mn in 2016E-2018E by our
estimate. However, we expect no cash dividend from SMIC in the foreseeable future as we
believe the Chinese government would not want SMIC to receive substantial government
support and pay cash dividend to foreign investors simultaneously.
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2013 2014 2015 2016E 2017E 2018E 2019E
US
$ m
n
Government grants (LHS) Gov grants/net profit % (RHS)
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 6
Exhibit 6: SMIC reports lower depreciation/revenue ratio and higher ROE than UMC Comparison of profitability among TSMC, UMC, and SMIC
Source: Company data, Gao Hua Securities Research
Exhibit 7: TSMC’s average depreciation/PPE is 26% TSMC’s depreciation, PPE, and depreciation/PPE %
Exhibit 8: UMC’s average depreciation/PPE is 27% UMC’s depreciation, PPE, and depreciation/PPE %
Source: Company data, Gao Hua Securities Research
Source: Company data, Gao Hua Securities Research
2014 2015 2016E 2017E 2018E 2014 2015 2016E 2017E 2018E
Revenue ($ mn) EBITDA ($ mn)
TSMC 25,169 26,567 29,389 32,221 35,244 TSMC 16,296 17,118 18,649 21,154 23,117
UMC 4,620 4,562 4,587 4,967 5,311 UMC 1,674 1,773 1,827 2,054 2,223
SMIC 1,970 2,236 2,910 3,622 4,339 SMIC 680 746 1,093 1,350 1,638
GPM % Net profit ($ mn)
TSMC 49.5% 48.7% 50.1% 51.0% 51.7% TSMC 8,708 9,834 10,451 11,507 12,949
UMC 22.7% 21.9% 20.1% 20.5% 23.0% UMC 401 424 276 314 481
SMIC 24.5% 30.5% 28.7% 27.1% 27.8% SMIC 150 253 375 380 414
EBITDA margin % Depreciation/revenue %
TSMC 64.7% 64.4% 63.5% 65.7% 65.6% TSMC 26.0% 26.0% 23.3% 25.3% 24.2%
UMC 36% 39% 40% 41% 42% UMC 29.0% 31.4% 35.7% 35.5% 33.0%
SMIC 35% 33% 38% 37% 38% SMIC 27.9% 23.4% 25.3% 27.2% 27.4%
EBIT margin % Capex/revenue %
TSMC 38.8% 38.4% 40.2% 40.3% 41.4% TSMC 37.8% 30.4% 34.6% 31.1% 28.7%
UMC 7.2% 7.5% 4.1% 5.9% 8.8% UMC 30.7% 41.2% 48.0% 29.8% 28.2%
SMIC 6.6% 9.9% 12.2% 10.1% 10.4% SMIC 33.2% 55.0% 91.2% 66.3% 55.3%
Net margin % Revenue/PP&E %
TSMC 34.6% 37.0% 35.6% 35.7% 36.7% TSMC 97.2% 102.2% 94.9% 96.3% 100.5%
UMC 8.7% 9.3% 6.0% 6.3% 9.1% UMC 87.6% 80.4% 73.0% 81.1% 90.5%
SMIC 7.6% 11.3% 12.9% 10.5% 9.5% SMIC 65.8% 57.3% 49.5% 49.6% 51.0%
ROE % Capex ($ mn)
TSMC 28.3% 28.0% 26.0% 24.9% 24.8% TSMC 9,514 8,085 10,167 10,018 10,129
UMC 5.6% 6.0% 4.0% 4.5% 6.6% UMC 1,416 1,881 2,201 1,479 1,496
SMIC 5.5% 7.6% 9.5% 8.7% 8.7% SMIC 653 1,231 2,654 2,400 2,400
Payable days Inventory days
TSMC 21.2 16.1 21.1 21.3 20.5 TSMC 60.3 54.6 37.6 37.9 36.6
UMC 20.0 18.6 21.2 21.2 21.0 UMC 49.3 55.1 62.9 62.9 62.2
SMIC 195.0 246.1 212.6 173.1 145.8 SMIC 77.6 91.0 90.3 86.5 85.7
Receivable days Working capital/sales
TSMC 52.8 35.8 49.8 47.6 48.1 TSMC 19.9% 15.2% 15.9% 15.3% 15.3%
UMC 55.9 47.1 54.1 55.2 53.7 UMC 21.5% 20.7% 23.9% 24.2% 23.4%
SMIC 84.6 81.6 83.3 78.6 79.9 SMIC -1.1% -7.2% -1.0% 4.2% 10.0%
0%
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E
TSMC
Depreciation PPE Depreciation/PPE
Average=26%
0%
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E
UMC
Depreciation PPE Depreciation/PPE
Average=27%
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 7
Exhibit 9: SMIC’s average depreciation/PPE is only 20%
SMIC’s depreciation, PPE, and depreciation/PPE %
Exhibit 10: We believe consensus is underestimating
SMIC’s depreciation SMIC’s capex, 7-year average capex, and depreciation
Source: Company data, Gao Hua Securities Research
Source: Company data, Bloomberg, Gao Hua Securities Research
Exhibit 11: SMIC has had an accumulated free cash
outflow of US$4bn since its IPO in 2004 SMIC’s EBITDA, capex, and free cash flow (EBITDA-capex) on
a consolidated basis (excluding minority cash contribution)
Exhibit 12: SMIC’s revenue/net PP&E has deteriorated
significantly since 2013 Revenue/PP&E + intangibles for TSMC, UMC and SMIC, %
Source: Company data, Gao Hua Securities Research
Source: Company data, Gao Hua Securities Research
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SMIC
Depreciation PPE Depreciation/PPE
Average=20%
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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
US
$ m
n
Capex-Write-off Depreciation Consensus depreciation Last 7-yr average capex
(1,800)
(1,500)
(1,200)
(900)
(600)
(300)
-
300
600
900
1,200
1,500
1,800
(2,800)
(2,400)
(2,000)
(1,600)
(1,200)
(800)
(400)
-
400
800
1,200
1,600
2,000
2,400
2,800
200
4
200
5
200
6
200
7
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
201
6E
201
7E
201
8E
US
$ m
n
US
$ m
n
EBITDA (LHS) Capex (LHS) EBITDA-Capex (RHS)
0%
20%
40%
60%
80%
100%
120%
140%
160%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Revenue/(Net PP&E+intangibles)
TSMC UMC SMIC
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 8
We revise TP methodology to offset depreciation policy differences
For our TP calculation, we earlier used 0.78X P/B derived from NTM P/B-ROE regression for
peers, which assumed SMIC’s book value and ROE are comparable to peers’ but did not
capture the impact of its different depreciation policy. Now, we move to EV/DACF (Director’s
Cut), which is based on gross assets and is not dependent on the depreciation policy.
The Director’s Cut methodology analyses how the market values the cash invested in a
business (EV/GCI) relative to the returns (value) created from those assets (CROCI/WACC).
GCI stands for Gross Cash Invested and includes gross fixed assets and working capital.
CROCI stands for Cash Return On Cash Invested, which is operating cash flow over GCI.
The implication is that the market either expects stocks above the regression line to see
accelerated returns relative to the sector, or is overvaluing them relative to cash return and
thus these represent good selling opportunities, and vice-versa (Exhibit 14). The underlying
assumption in this framework is that a company’s ratio will converge to the sector average
over the long term as under/overvaluation is arbitraged away. Foundry and packaging
stocks have historically shown a high correlation in EV/GCI vs. CROCI/WACC (Exhibit 15).
Our regression is built on SMIC’s peers in foundry/packaging in 2017E plus UMC/SMIC in
past troughs. We derive our target EV/DACF from the EV/GCI and CROCI/WACC we get
from the regression. To factor in SMIC’s fast growth in 2017E-2019E, we then calculate
2019E EV based on the target EV/DACF and 2019E DACF. This gives us an implied 2019E
value per share of HK$10.33, which we discount to 2017E with SMIC’s COE of 10.7% to
derive our new 12-month target price of HK$8.40. Our revised target price implies 1.19X
2017E P/B and represents 24% downside potential.
Exhibit 13: We factor in SMIC’s superior growth potential in 2017E-2019E in our valuation methodology
Our 12-month target price calculation for SMIC (value per share in HK$)
Source: Gao Hua Securities Research
Exhibit 14: We use a regression of peer CROCI/WACC vs.
EV/GCI to determine our target EV/GCI for SMIC A regression of EV/GCI and NTM CROCI/WACC of foundry
and packaging stocks in 2017E
Exhibit 15: We use historical data to cross check our
regression A regression of EV/GCI and NTM CROCI/WACC of foundry
and packaging stocks based on historical data
Note: Different shapes for different firms, different colors for different years
Source: Company data, Gao Hua Securities Research
Source: Company data, Gao Hua Securities Research
COE
8.40 4,546.1 1.09 0.34X 4.8x 2,008 9,705 10.33 10.7%(a) = (g) / (1 + (h))^2 (b) (c) (d) (e) (f) = (e) * (d) (g) (h)
2019 DACF (US$ mn)
Implied 2019 value per share
Implied 2017 value per share
Implied market cap ($mn)
SMIC 2017E CROCI/WACC
Target EV/GCI Implied target
EV/DACF Implied 2019 EV (US$ mn)
UMC 2009
SMIC 2009
TSMC
UMCHua Hong
ASE
SPIL
SMIC current
y = 0.4925x - 0.22
R² = 0.9734
-
0.20
0.40
0.60
0.80
1.00
1.20
1.40
- 0.50 1.00 1.50 2.00 2.50 3.00
EV
/GC
I
CROCI/WACC
y = 0.4283x - 0.0923
R² = 0.88
-
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
- 0.50 1.00 1.50 2.00 2.50 3.00 3.50
EV
/GC
I
CROCI/WACC
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 9
Exhibit 16: SMIC has superior sales/GCI than UMC due to
higher utilization and newer equipment Comparison of foundry sales/GCI
Exhibit 17: UMC converts slightly more sales to cash flow
than SMIC due to UMC’s superior EBITDA margin Comparison of foundry DACF/Sales
Source: Company data, Gao Hua Securities Research
Source: Company data, Gao Hua Securities Research
Risks include higher-than-expected government R&D subsidies and open market stock
purchases by government related entities. We note that between Nov 1 and Dec 9,
Tsinghua Unigroup acquired 298mn shares or 7.07% of total shares outstanding of SMIC at
an average of c.HK$10 per share.
Our 2016E-2018E EPS estimates are below consensus
We raise our 2016E-2018E EPS estimates by 15%/146%/84% as we increase our revenue
and R&D grant estimates and lower our depreciation estimates. We believe SMIC can
achieve its revenue CAGR target of 20% in 2016E-2019E given the strong support it receives
from the Chinese government. In 2016-2018, our revenue estimates are above consensus,
but our EPS estimates are still well below consensus because of our higher depreciation
estimates.
Exhibit 18: We adjust our 2016-18E EPS by 15%/146%/84% SMIC estimate revisions
Source: Gao Hua Securities Research
10%
15%
20%
25%
30%
35%
40%
45%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E
Revenue/GCI
TSMC UMC SMIC Hua Hong
10%
20%
30%
40%
50%
60%
70%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E
DACF/Revenue
TSMC UMC SMIC Hua Hong
SMIC
New Old Diff. New Old Diff. New Old Diff.
Revenue ($ mn) 2,910 2,903 0.2% 3,622 3,424 5.8% 4,339 4,003 8.4%
Gross margin (%) 28.7% 28.4% 33bps 27.1% 39.3% -1218bps 27.8% 48.1% -2032bps
Operating profit ($ mn) 356 343 4.0% 365 152 140.0% 451 220 105.3%
Operating margin (%) 12.2% 11.8% 44bps 10.1% 4.4% 564bps 10.4% 5.5% 491bps
Net profit ($ mn) 375 326 15.1% 380 155 145.6% 414 225 84.3%
Net margin (%) 12.9% 11.2% 166bps 10.5% 4.5% 598bps 9.5% 5.6% 393bps
EPS ($)-HK shares 0.078 0.067 15.1% 0.076 0.031 145.6% 0.082 0.045 84.3%
Wafer shipments (K 8" wafers) 3,971 3,839 3.4% 4,909 4,363 12.5% 5,790 5,113 13.2%
ASP ($) 706 708 -0.3% 718 724 -0.8% 732 738 -0.8%
Capacity ('000 8" eq) 3,998 4,024 -0.6% 5,168 5,114 1.1% 6,070 5,908 2.7%
Utilization 99.3% 95.4% 391bps 95.0% 85.3% 966bps 95.4% 86.5% 885bps
Capex ($ mn) 2,600 2,500 4.0% 2,400 2,000 20.0% 2,400 2,000 20.0%
Depreciation ($ mn) 736 737 -0.1% 985 1,090 -9.6% 1,187 1,284 -7.6%
2016E 2017E 2018E
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 10
Exhibit 19: We expect SMIC to hit its revenue growth target, but are conservative on earnings GHe vs. consensus
Source: Bloomberg, Gao Hua Securities Research.
Exhibit 20: SMIC’s valuation looks expensive relative to peers
Valuation comparison, as of January 17, 2017
Note: All target prices have a 12-month timeframe
Source: Company data, Datastream, Gao Hua Securities Research, Goldman Sachs Global Investment Research.
Note: Prices in this report are as of January 17, 2017 market close, unless indicated
otherwise.
GH e Consensus Diff. GH e Consensus Diff. GH e Consensus Diff.
Revenue (US$ mn) 2,910 2,908 0.1% 3,622 3,538 2.4% 4,339 4,094 6.0%
Gross margin (%) 28.7% 28.8% -3bps 27.1% 28.6% -146bps 27.8% 28.6% -80bps
EBITDA (US$ mn) 1,093 1,073 1.8% 1,350 1,329 1.6% 1,638 1,590 3.0%
EBITDA margin (%) 37.5% 36.9% 65bps 37.3% 37.6% -28bps 37.7% 38.8% -109bps
Operating profit (US$ mn) 356 369 -3.3% 365 413 -11.6% 451 492 -8.4%
Operating margin (%) 12.2% 12.7% -43bps 10.1% 11.7% -159bps 10.4% 12.0% -163bps
Net profit (US$ mn) 375 374 0.3% 380 423 -10.1% 414 476 -13.1%
Net margin (%) 12.9% 12.9% 3bps 10.5% 12.0% -146bps 9.5% 11.6% -209bps
Capex (US$ mn) 2,600 2,452 6.0% 2,400 2,047 17.2% 2,400 1,969 21.9%
Depreciation (US$ mn) 736 547 34.7% 985 717 37.4% 1,187 867 37.0%
2017E 2018E 2016E
Ticker Ratings Market Target TP Market
capCash div
yieldPrice Price up/downside US$ mn 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E 2016E
Hua Hong (HK$) 1347.HK Buy 8.26 10.50 27% 1,101 11.1 11.3 0.7 0.7 6.5% 6.1% 9.6% 10.0% 3.3%
Silergy (NT$) 6415.TW Buy 470.50 528.00 12% 1,143 28.2 18.8 5.3 4.3 23.9% 26.7% 50.3% 35.0% 1.0%
TSMC (NT$) 2330.TW Neutral 181.00 190.00 5% 148,420 13.9 12.8 3.4 3.0 25.8% 24.9% 12.4% 8.6% 3.3%
TSMC-ADR (US$) TSM Neutral 29.62 27.20 -8% 153,456 13.3 13.2 3.2 3.1 25.8% 24.9% 12.4% 8.6% 3.1%
UMC (NT$) 2303.TW Neutral 11.65 13.30 14% 4,784 16.1 14.2 0.6 0.6 4.0% 4.5% 2.1% 7.3% 5.3%
UMC-ADR(US$) UMC Neutral 1.85 2.10 14% 4,800 16.0 14.1 0.6 0.6 4.0% 4.5% 2.1% 7.3% 5.2%
SMIC (US$) SMI Sell 7.09 5.40 -24% 5,989 18.3 18.7 1.8 1.7 9.5% 8.7% 30.1% 24.5% 0.0%
SMIC-H shares (HK$) 0981.HK Sell 11.06 8.40 -24% 6,129 18.4 18.8 1.8 1.7 9.5% 8.7% 30.1% 24.5% 0.0%
Intel (US$) INTC Neutral 36.80 39.00 6% 179,474 17.7 14.3 2.8 2.6 18.6% 18.7% 6.0% 5.4% 2.8%
MediaTek (NT$) 2454.TW Neutral 213.50 248.00 16% 10,615 13.9 13.2 1.4 1.4 10.0% 10.5% 29.9% -1.6% 5.8%
Parade (NT$) 4966.TWO Neutral 308.00 329.00 7% 740 17.4 14.4 3.2 2.7 19.8% 21.0% 25.5% 23.2% 2.1%
Samsung Electronics (KRW) 005930.KS Neutral 1,848,000 1,880,000 2% 220,261 11.5 11.5 1.4 1.4 12.8% 12.8% 0.4% 11.4% 1.5%
Average 16.3 14.6 2.2 2.0 14.2% 14.3% 17.6% 13.7% 2.8%Median 16.0 14.1 1.8 1.7 11.4% 11.6% 12.4% 9.3% 3.0%STD 4.5 2.7 1.4 1.2 8.2% 8.4% 15.4% 10.6% 2.0%
P/E (X) P/B (X) ROE Revenue growth
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 11
Disclosure Appendix
Reg AC
I, Donald Lu, Ph.D, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or
companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific
recommendations or views expressed in this report.
Investment Profile
The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and
market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites
of several methodologies to determine the stocks percentile ranking within the region's coverage universe.
The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows:
Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate
of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend
yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends.
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GS SUSTAIN
GS SUSTAIN is a global investment strategy aimed at long-term, long-only performance with a low turnover of ideas. The GS SUSTAIN focus list
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Disclosures
Coverage group(s) of stocks by primary analyst(s)
Donald Lu, Ph.D: Greater China Telecoms and Technology.
Greater China Telecoms and Technology: China Communication Services, China Mobile (HK), China Mobile (HK) (ADR), China Telecom, China
Telecom (ADR), China Unicom, China Unicom (ADS), Hua Hong Semiconductor Ltd., Mediatek, Parade Technologies Ltd., Silergy Corp., SMIC, SMIC
(ADR), Sunny Optical Technology Group, TSMC, TSMC (ADR), United Microelectronics Corp., United Microelectronics Corp. (ADR), ZTE Corp. (H).
Company-specific regulatory disclosures
The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies
covered by the Global Investment Research Division of Goldman Sachs and referred to in this research.
Goldman Sachs had a non-securities services client relationship during the past 12 months with: SMIC (HK$10.88) and SMIC (ADR) ($7.05)
Goldman Sachs makes a market in the securities or derivatives thereof: SMIC (HK$10.88) and SMIC (ADR) ($7.05)
Goldman Sachs is a specialist in the relevant securities and will at any given time have an inventory position, "long" or "short," and may be on the
opposite side of orders executed on the relevant exchange: SMIC (HK$10.88) and SMIC (ADR) ($7.05)
Distribution of ratings/investment banking relationships
Goldman Sachs Investment Research global Equity coverage universe
Rating Distribution Investment Banking Relationships
Buy Hold Sell Buy Hold Sell
Global 32% 54% 14% 64% 60% 51%
As of January 1, 2017, Goldman Sachs Global Investment Research had investment ratings on 2,902 equity securities. Goldman Sachs assigns stocks
as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell
for the purposes of the above disclosure required by the FINRA Rules. See 'Ratings, Coverage groups and views and related definitions' below. The
Investment Banking Relationships chart reflects the percentage of subject companies within each rating category for whom Goldman Sachs has
provided investment banking services within the previous twelve months.
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 12
Price target and rating history chart(s)
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4.84.7
6.9
7.4
6,0007,0008,0009,00010,00011,00012,00013,00014,00015,00016,000
4.005.006.007.008.009.00
10.0011.0012.0013.0014.00
SMIC (0981.HK)
Goldman Sachs rating and stock price target history
Stock Price Currency : Hong Kong Dollar
Source: Goldman Sachs Investment Research for ratings and price targets; FactSet closing prices as of 12/31/2016.
The price targets show n should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as w ell as developments relating to the company, its industry and financial markets.
Rating
Price target
Price target at removal
Covered by Donald Lu, Ph.D,as of Apr 19, 2016
Not covered by current analyst
Hang Seng China Ent. Index
Inde
xPr
ice
Sto
ckPr
ice Apr 19
NAF
SM A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D
2014 2015 2016
3.13
4.4
4.7
3,5003,7003,9004,1004,3004,5004,7004,9005,1005,3005,500
2.00
3.00
4.00
5.00
6.00
7.00
8.00
SMIC (ADR) (SMI)
Goldman Sachs rating and stock price target history
Stock Price Currency : U.S. Dollar
Source: Goldman Sachs Investment Research for ratings and price targets; FactSet closing prices as of 12/31/2016.
The price targets show n should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as w ell as developments relating to the company, its industry and financial markets.
Rating
Price target
Price target at removal
Covered by Donald Lu, Ph.D,as of Apr 19, 2016
Not covered by current analyst
NASDAQ Composite
Inde
xPr
ice
Sto
ckPr
ice Apr 19
NAF
SM A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D
2014 2015 2016
January 19, 2017 SMIC (0981.HK)
Goldman Sachs Global Investment Research 13
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Goldman Sachs Global Investment Research 14
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