Why were longer-term profit forecasts cut if the demand outlook is unchanged?

  • Goldman Sachs maintained its earnings forecasts for SMIC for 2026 and 2027, but cut its net profit forecasts for 2028 and 2029 by 14% and 7%, respectively. The main adjustment concerns average selling prices for advanced processes: as new capacity ramps up and the product and customer mix broadens, the bank expects price increases to be more gradual than previously forecast.
  • A small revenue adjustment is amplified by changes in margins. The 2028 revenue forecast was cut by 2% to 18.009 billion dollars, the gross margin was lowered from 29.1% to 27.5%, and the expense ratio assumption was raised by a further 0.3 percentage points. As a result, net profit was lowered from 2.579 billion dollars to 2.219 billion dollars.
  • The 2029 revenue forecast was cut by 1%, the gross margin forecast by 0.8 percentage points, and net profit to 3.123 billion dollars. Goldman Sachs still expects AI demand and an upgraded product mix to drive year-on-year increases in advanced-process selling prices, but by less than previously assumed.

How can AI drive both advanced and mature processes?

  • The link to advanced processes is domestic AI chips: expansion of China’s AI chip market will increase related wafer foundry demand. Mature processes also have areas that benefit, including AI-related analog chips and power semiconductors, so demand support is not limited to computing chips themselves.
  • Another avenue comes from global foundry capacity allocation. Goldman Sachs believes leading international foundries’ allocation of more capacity to AI and leading-edge processes will create opportunities for Chinese foundries to serve non-AI and mature-process demand; domestic substitution and customers’ diversification of suppliers also support SMIC’s growth.

Why might capacity expansion not lift profitability in tandem?

  • New capacity creates room for more revenue, but also increases the depreciation burden. Goldman Sachs expects high utilization and improved selling prices to offset only part of the additional depreciation, so the profit impact of expansion will also depend on capacity utilization and the pace of price increases.
  • This constraint is already reflected in the model: revenue is forecast to grow 25% year on year in 2028, but the operating margin is expected to be 16.1%, below 16.5% in 2027; net profit growth also slows from 29% to 22%. Revenue growth remains fast, but margin improvement is not smooth year after year.
  • There are specific conditions on both the demand and supply sides: weaker-than-expected demand for smartphones and consumer electronics would affect the order base; slower-than-expected product diversification or capacity expansion would weigh on growth. SMIC is on the U.S. BIS Entity List, and its access to some equipment and materials may also be restricted.

Why is the price target unchanged despite lower earnings forecasts?

  • Goldman Sachs maintained its buy rating and 12-month target price of 153 Hong Kong dollars for the H shares, while rolling the valuation basis forward from 2028 to 2029. The new approach uses 66.7 times expected 2029 earnings, compared with the previous 80.7 times expected 2028 earnings, and discounts the result to 2027 using a cost of equity of 15%.
  • The unchanged price target accompanies changes to the valuation year and multiple, and should not be viewed simply as an unchanged earnings assessment. The A-share target price of 257.9 yuan also remains unchanged, continuing to be based on a 196% valuation premium to the H shares, derived from the average since January 2024.