CITIC SEC: AI is the biggest DRIVER of the semiconductor industry, looking at domestic alternatives in the cloud and downstream increment in terminals.

CITIC SEC releases research report stating that the current semiconductor cycle is still in an upward trend, with AI continuing to be strong and the industrial sector taking over from consumer electronics entering a stage of recovery. Looking ahead, CITIC SEC believes that AI will continue to be the biggest driver of growth in the semiconductor industry. On one hand, the demand for cloud-based AI continues to grow, and on the other hand, the accelerated adoption of AI applications at the end is expected. Chinese semiconductor manufacturers are expected to significantly benefit from the subsequent development of the AI industry. From the perspective of listed companies, the investment logic can be divided into two main lines, with domestic substitution in the cloud and downstream increment in the end. Key points from CITIC SEC: AI is the biggest driver of the semiconductor industry. The global semiconductor industry entered an upward cycle from 23Q2, with overseas semiconductor industry (especially in North America) maintaining high growth rates (around 20%) due to AI infrastructure. The domestic semiconductor industry benefits relatively weakly from AI, and it is more affected by the recovery of consumer electronics. Sales growth in 24H2 has slowed down, and sales growth in 25H1 in the industrial sector taking over from consumer electronics has started to pick up. Looking ahead, it is expected that AI will still be the biggest driver of the semiconductor industry, with domestic substitution in the cloud and downstream increment in the end. Cloud-based substitution: Advanced process is the foundation of domestic computing power, while accompanying storage/equipment is expected to rise. Since the beginning of the year, the overseas AI industry has been exceeding expectations, while domestic large models continue to iterate and narrow the gap with overseas models, driving the continuous growth of domestic computing power demand. At the same time, the trend of domestic computing power expansion is irreversible and is expected to drive the development of the entire domestic computing power industry chain. Combining the urgency of domestic substitution and the scarcity of assets, we believe that the most important aspect of the domestic computing power chain is the advanced process, with a focus on computing power chips/advanced storage/upstream equipment. Specifically, 1) Computing power chips: As a direct beneficiary of cloud-based computing power, domestic computing power manufacturers are expected to accelerate the pace of customer deployment. 2) Advanced process: Domestic availability of advanced process is the foundation of computing power. Semiconductor Manufacturing International Corporation, as a scarce supplier of advanced process domestically, has strengthened its industry position, and we are optimistic about Semiconductor Manufacturing International Corporation expanding its advanced process and significantly improving the company's overall profitability (Taiwan Semiconductor Manufacturing Company's gross profit margin in 25H1 focusing on advanced process is 58%, while the company's current gross profit margin is less than 25%); 3) Advanced storage as a complement to computing power, its domestication process is expected to accelerate: in terms of HBM, we expect the proportion of DRAM production value to exceed 30% by 2025, currently monopolized by overseas giants, with domestic manufacturers gradually breaking through; in the enterprise-level SSD sector, according to IDC, the domestication rate of enterprise-level SSD in China is approximately 35% by 2023, with multidimensional drivers accelerating domestication; 4) At a deeper level, in terms of advanced process/storage, one must look at the comprehensive breakthrough of domestic equipment. We are optimistic that 2026 will be a major year for the expansion of advanced process/storage, with a focus on bottlenecks (low domestication rates) such as lithography equipment, high-end thin film equipment, high aspect ratio etching equipment, volume detection equipment, and coating/development equipment. End-use increment: Accelerated adoption of applications brings considerable incremental demand, with a focus on upgrading the main control/storage/sensor three major hardware directions of terminal AI. The upgrade of large models is expected to accelerate the deployment of AI applications, with the end as the hardware carrier of AI applications having considerable growth potential. We believe that smart hardware such as AIoT smart driving will bring new semiconductor demand, and we recommend focusing on the intelligent upgrade directions of the main control/storage/sensor three major hardware of terminal AI. Among them, 1) Main control upgrade (focus on glasses SoC): Model deployment places higher demands on the main chip (such as integrated NPU), bringing value increase, and the release of new products may bring incremental demand. Considering the industry penetration rate and long-term growth space, we believe that for domestic SOC manufacturers, the most important aspect to consider is the glasses scene. Global shipments of AI glasses are expected to reach 2-3 million pairs by 2024, with an expected 8 million pairs in 2025, and over 20 million pairs by 2026+, with enormous growth potential in the long term; 2) Storage upgrade (focus on 3D DRAM): 3D DRAM is expected to become an important solution for reasoning terminals, and we expect initial deployment in AIoT, AI phones, and other scenarios. In this context, domestic storage manufacturers are expected to accelerate entry into the middle to high-end storage market through customized solutions; 3) Sensor upgrade (focus on car CIS): High-end smart driving trends drive the volume and price increase of CIS (we expect the demand for automotive cameras to reach 130-140 million units by 2025, a nearly 60% increase over the previous year), and the market share of local manufacturers is expected to further rise. Industry integration, capital support. 1) Mergers and acquisitions are another important trend in the semiconductor industry, with various segments of the domestic industry entering the integration phase. While there are many domestic semiconductor manufacturers, "small and beautiful" is the main characteristic, with a size gap compared to overseas giants. With the change in the stage of industrial development, the domestic semiconductor industry is entering an era of merger and acquisition as it moves from the era of "Spring and Autumn" with many flowers in full bloom to the "Warring States" era with a concentration of leading companies. Currently, there are clear signs that the domestic semiconductor industry is gradually transitioning from the era of diverse development to the era of concentrated leadership, with more mergers and acquisitions projects appearing in areas such as equipment/analog/EDA, which will help the development of platform-leading companies. 2) Accelerated IPO acceptance + A to H listing wave, improving semiconductor financing environment. In the A-share market, since Q2 of this year, the progress of IPOs of key semiconductor companies has accelerated significantly, with 14 semiconductor companies having IPO applications accepted since Q4 of 24. In Hong Kong stocks, by the end of July, local semiconductor companies were accelerating their listing on the Hong Kong capital market, including 11 local semiconductor companies that have not yet listed submitting IPO applications, and 11 A to H listings of A-share companies. Overall, the trend of tighter semiconductor financing is expected to see a turnaround, with high-quality semiconductor leading companies benefiting from policy and capital market support, accelerating domestic substitution, and simultaneously laying out a global vision and entering overseas markets. Risk factors: Innovation at the end is not as expected; the domestic substitution process is not as expected; intensified market competition; increased risks from changes in the international industrial environment and trade frictions; slower-than-expected progress in industrial mergers and acquisitions, etc. Investment strategy The trend worth watching in the Chinese semiconductor industry in the second half of 2025 is still AI, accompanied by accelerated mergers and acquisitions and an improving financing environment, which are two other trends worth noting. Specifically, the overseas AI industry has been exceeding expectations, while domestic large models continue to iterate and narrow the gap with overseas models, driving the continuous growth of domestic computing power demand. The benefit of the domestic semiconductor industry under the new wave of AI is significantly increasing. We have identified two main strategies: 1) domestic substitution in the cloud; 2) downstream increment in the end.