Citi: Upgrades target prices and earnings forecasts for Semiconductor Manufacturing International Corporation (00981) and Hua Hong Grace Semiconductor (01347). Next quarter's performance exceeds expectations, and this quarter's guidance is positive.

Citigroup released a research report stating that Semiconductor Manufacturing International Corporation (00981) and Hua Hong Grace Semiconductor (01347) recently reported their second-quarter performance, indicating an increasingly clear recovery in the foundry industry for mature processes and specialty technologies; capacity utilization has rebounded, there is a trend of rising prices, and a tight capacity cycle. At the same time, artificial intelligence is creating direct demand for PMIC/MCU/power devices and has an indirect "capacity spillover" effect on mature processes. The bank believes that both companies began price negotiations for tight supply products (especially 8-inch and AI-related products) in the first quarter. Hua Hong also mentioned that high factory load is causing longer delivery times, especially in the BCD/PMIC, MCU, flash memory, and power processes. This is creating a healthier environment for the industry outlook. Citigroup has raised its earnings per share forecast for SMIC and Hua Hong for 2026/27 by 10% to 39%, reflecting the improvement in pricing and the outlook for capacity utilization that enhances profitability. The bank maintains a "Buy" rating for both SMIC and Hua Hong. The target price for SMIC's H-shares has been increased from HKD 90 to HKD 100, based on an unchanged price-to-book ratio of 4 times, applied to the average book value per share for 2026/27. The target price for Hua Hong's H-shares has been raised from HKD 160 to HKD 175, based on an unchanged price-to-book ratio of 5 times, applied to the average book value per share for 2026/27. The target price-to-book ratios are both two standard deviations above their historical ranges, due to the improvement in terminal demand prospects and the recovery trend in pricing and capacity utilization. The bank stated that both SMIC and Hua Hong delivered better-than-expected second-quarter results, confirming that the recovery in Chinas wafer foundry industry has expanded from AI accelerators to mature processes and specialty products. SMIC reported revenues of USD 3 billion (up 20% quarter-over-quarter, up 36% year-over-year), with gross margin rising from 20.1% to 25.3%, significantly higher than the previous guidance of 20% to 22%; capacity utilization also rose to 93.7%. Hua Hong recorded a record revenue of USD 718 million (up 9% quarter-over-quarter, up 27% year-over-year), with gross margin increasing to 16.5%, benefiting from improved shipment volumes and average selling prices. Hua Hongs strong growth was driven by embedded non-volatile memory/MCU (up 42% year-over-year), standalone non-volatile memory/flash memory (up 149% year-over-year), logic/RF (up 21% year-over-year), and analog/PMIC (up 13% year-over-year). A common theme is that the recovery in sales is now supported by reinforced pricing, which, despite new capacity bringing higher depreciation, is still generating significant operational leverage. Citigroup noted that the outlook for both companies in the third quarter is positive, with both expecting momentum to carry into the third quarter. SMIC has guided for revenue growth of 2% to 4% quarter-over-quarter, with gross margin ranging between 26% and 28%. Management believes that the "spillover effect" of artificial intelligence will persist into the second half of 2026, and they are accelerating the certification of new capacity to address supply shortages. Hua Hong's outlook is even stronger, guiding for revenue of USD 770 million to USD 780 million, representing an increase of approximately 8% quarter-over-quarter, with gross margin expected to be between 16% and 18%. Management indicated that the incremental revenue is indeed a combination of rising sales volume and increasing average selling prices, with particularly strong performance in MCU/embedded memory, standalone flash memory, low-to-mid voltage MOSFETs, RF, and PMIC. More importantly, Hua Hong expects the momentum in MCU and standalone memory to continue into 2026 and 2027, indicating that the recovery is becoming more structural rather than merely a replenishment cycle of inventory.