SMIC Unaffected By Smartphone Worries, Boosted By Chinese Government Support: How To Play It

• Shares of Semiconductor Manufacturing Int'l (ADR) SMI have declined 35 percent in the past two months on concerns regarding China’s macro environment.
• Bernstein’s Mark Li has upgraded the rating on SMIC from Market Perform to Outperform, with a price target of HK$0.88.
• Li believes that the stock has 42 percent upside, with smaller players like SMIC outgrowing its larger rivals as the smartphone growth moderates.

Li expects foundry growth to weaken as the smartphone market’s growth moderates. The impact of this is likely to vary across individual players in the markets, based on their size and exposure to the smartphone segment.

Given SMIC’s limited smartphone exposure, Li believes that the company would be unscathed by concerns regarding the smartphone market, while benefiting from “thriving Chinese fabless & government support.”

Government support is likely to lead to accelerated growth of the semiconductor industry in China, and SMIC is expected to the primary beneficiary.

“The management team has proven themselves with the consistent profitability of 13 quarters consecutively,” Li stated, adding that “SMIC's different customer base and market exposure shields it from the sluggish smartphone market.”

Going forward, the Bernstein report sees 28nm as a growth driver for the company, with the 8” fab in Shenzhen expected to capture growing demand in lagging nodes. Li expects the company to report healthy top-line growth with conservative EPS growth, driven by a margin drag due to the 28nm ramp. However, this drag is expected to fade and EPS expected to grow 13 percent in 2017.

The company reported its 2Q15 results and 3Q15 guidance better than that of its peers. Li believes that the stock offers an attractive entry point for long term investors.