Key Takeaways:

• SMIC expects third-quarter revenue to grow 3% to 5% quarter on quarter, but predicts a seventh straight quarterly fall in gross margin to between 18% and 20%
• The chip maker’s revenue and net profit in the second quarter beat market estimates   

By Ken Lo

Leading Chinese chip company Semiconductor Manufacturing International Corp. (SMIC, 0981.HK; 688981.SH) has beat market expectations with its latest quarterly earnings, but the going is still tough under the shadow of U.S. sanctions and global economic uncertainty.

Profit margins still came under sustained pressure. Gross margin slipped to 20.3% in the three months to the end of June, marking a sixth straight quarterly decline.

The company predicted third-quarter revenue would grow 3% to 5% from the prior quarter, a slightly slower sequential pace than for the previous three months. SMIC forecast that its gross margin would edge down to between 18% and 20% in the quarter to end-September, a seventh consecutive quarterly drop, as falling chip prices offset rising sales volumes.

Co-CEO Zhao Haijun told an earnings briefing that an expected rebound in chip demand had been held back by macroeconomic factors, which were sapping demand for smartphones and other consumer electronics, and he was not optimistic about any robust recovery next year.

The company said demand for 12-inch silicon wafers was still strong during the quarter. Customer demand for 8-inch wafers was weaker, with lower capacity utilization than for the 12-inch wafers but the rate was still higher than the industry average, SMIC said. R&D spending rose 6% to $178 million in the second quarter from $168 million in the prior quarter, accounting for about 11.4% of revenues, close to the level in the first quarter.

According to Zhao, demand for 8-inch wafers remains robust, with especially large orders for the 0.18-micron process technology. With a supply shortage of standard 8-inch wafers and a cost advantage, SMIC said it is making every effort to get the R&D and technology in place to provide the production capacity for a growth cycle as quickly as possible.

By region, China’s share of revenues grew from 75.5% in the first quarter to 79.6% in the second quarter. The combined share of U.S., European and Asian regions fell from 24.5% to 20.4%. Zhao said overseas customers are generally the leading suppliers of electronic products and find it harder to reduce orders in real time than lower ranked suppliers, due to long-term contracts signed during last year’s industry downturn.

Chinese companies started to control inventory as early as September last year, he said, while European and American customers only introduced more stringent order and inventory management in the second quarter of this year.

Zhao also said inventories of some chips in China had begun to decline, creating replenished chip demand for new products. U.S. and European markets may need to go through the same inventory cycle, sparking replacement demand after two quarters.

Sanctions Not Curbing Investment

The United States has been stepping up controls on China’s access to powerful chips and semiconductor technology that could be put to military use, and has been lobbying other countries to apply similar curbs.

SMIC has been the main target of U.S. sanctions against the Chinese chip industry since 2020. ASML had already put an embargo on sales of advanced extreme ultraviolet (EUV) technology to China, in line with U.S. controls. But a Reuters report in June said the Dutch government would block shipments of about six DUV lithography machines to Chinese companies, one of them belonging to SMIC.

In addition, Japan has imposed 23 export restrictions on China since July 23, with the targets including exposure machines, etching machines and other equipment needed to produce 14-nanometer and more advanced chips, joining the U.S. and the Netherlands in blocking China’s production of chips at 14-nanometer nodes or smaller.

SMIC’s management did not refer to the sanctions in its financial report or earnings briefing, but the market has been wondering if the company will adjust its capital spending in response to the slow market recovery. Zhao said the group never deviates from a goal of large-scale and high-speed investment to increase production capacity, but that it will track market conditions and liaise closely with customers to meet demand for new products.

Last year SMIC began production of 12-inch wafers, using 28-nanometer processes, at facilities it had built in the Shanghai Lin-gang Special Area. The company’s Beijing Jingcheng project is also expected to go into production in 2024. The sanctions do not appear to have slowed SMIC’s investment pace, with capital expenditure of $2.99 billion in the first half of the year.