One Market Leading Semiconductor Stock in China you should monitor

On May 15th, 2020, The U.S. government enacted new sanctions on Chinese tech giant Huawei Technologies.

These sanctions come into effect in September and will, once again, create disruptions in the global semiconductor supply chain. That said, it is not all doom and gloom. One Chinese chipmaker could benefit from such disruptions: Semiconductor Manufacturing International Corporation (SEHK: 981).

In this article, we will look at exactly why this company is poised to thrive, and to understand things clearly we have to look at the broader picture.

TSMC halts new orders from Huawei

For those who are unaware, the new rule requires a special license issued by the US officials, which will control foreign semiconductor makers that use American chipmaking equipment from exporting directly to Huawei without the US government’s consent.

The new sanction will further restrict companies such as Taiwan Semiconductor Manufacturing Co., otherwise known as TSMC, from providing semiconductors to Huawei. TSMC is one of the world’s largest chipmaker contractors and can produce the most advanced computing chips.

On the 18th of May, TSMC announced that they would halt new orders from Huawei.

This business decision possibly boils down to TSMC’s strong reliance on high-precision manufacturing equipment made in the US, as well as difficulties switching to alternatives given limited options available in the market.

But TSMC’s hesitance has created an opportunity for one of China’s largest domestic chipmakers – Semiconductor Manufacturing International Cor (SMIC)p., a potential alternative to TSMC for Huawei.

A company that benefits: SMIC

Last year, Huawei assigned SMIC to produce its new 14nm Kirin 710A mobile processors in anticipation of losing access to TSMC.

As a result of this deal, SMIC’s first-quarter earnings saw an uptick. The company reported an all-time high revenue of $908 million, which translates to an increase of 7.8% year-over-year. This was because of stronger maker demands and a better product mix. It also was because of Huawei, which accounted for 20% of the company’s revenue.

SMIC continues to capture growth opportunities in the domestic market. The company’s capital expenditures were up 57.9% year-on-year. It also increased its  planned capital expenditure from USD $3.2 billion  to USD $4.3 billion for further expansion in production facilities.

Furthermore, SMIC sequentially announced its plan to raise more than US 3 billion in the Shanghai’s STAR market, as well as securing funding that worth USD $1.2 billion from Chinese state investors.

Clearly, the proceeds shall be used to for increasing manufacturing capacity, as well as research and development in chipmaking technology to catch up with market rivals.

Just between the series of announcements in state-funding, IPO plans, and the company’s latest earnings, SMIC’s stock price soared up by more than 30% to a 52-weeks high of $20.7. From a short-term view, it has been generating very lucrative returns to speculators in the market.

The Challenge

Yet, it is still important to understand the fundamentals leading to SMIC’s future success.

The truth is SMIC’s chip technology is still several years behind of TSMC. This remains the core obstacle for SMIC to fully take over Huawei’s orders from TSMC. For those unfamiliar with the semiconductor industry, the smaller the nanometer level of the chip, the higher the precision is required in the fabrication process.

SMIC latest development only involves mass-producing 14-nanometer chips in 2019, whilst TSMC has already started to build a cutting-edge chip plant in Arizona for its 5nm chips production– the smallest and power-efficient chip available.

Moreover, political pressure from the U.S. government has caused SMIC to lose a USD $150 million deal with one of the top suppliers in the chip making equipment industry, Advanced Semiconductor Material Lithography (ASML) (NASDAQ: ASML). ASML  holds the critical technology (EUV equipment) for SMIC to make chips under 7 nanometers.

These political disruptions have led to China betting big on SMIC, injecting it with a substantial amount of capital for research and development in chip-making technology. A favorable outcome will allow China to sustain its semiconductor ecosystem, as well as close its technology gap with other countries.

Technology Breakthrough

With  the state’s financial support and its position as China’s leading foundry, SMIC has been working hard to develop its own version of the 7nm chip – the N+1 processor. It has recently scheduled to begin limited production in fourth quarter of 2020.

According to SMIC, N+1 is not employed with an EUV equipment. The product is therefore a substitute to the 7nm technology and is positioned for low-cost applications.

SMIC also admitted that there is still rooms for improvement when it comes to chip performance. However, it’s relatively 10% more cost effective when compared to 7nm. This creates comparative advantages to its tech-advanced competitors in the market.

Without a doubt, SMIC should already be undergoing the development of N+2 processor, which is expected to render higher performance relative to N+1. Business collaboration with Huawei may create synergies as they transfer valuable know-how from previous collaborations with TSMC, which in turn may accelerate SMIC’s technology enhancement process.

Despite facing difficulties in the short term, SMIC is deemed to succeed in becoming the market leader of producing cutting-edge domestic chips in the long term.

Foolish Conclusion

Recognised as the company leading the charge in China’s semiconductor industry, the future business potentials of SMIC is limitless.

Linking everything together, by developing their own technologies and being autonomous in the domestic market, it shall obsolete existing foreign technologies.

By developing their own technologies and becoming autonomous in the domestic market, SMIC has the chance to make foreign technologies unneeded in China. This in turn could expand their market share within the domestic market and help China become a technology titan in its own right.