Why cut profit forecasts while remaining positive on demand?

  • The changes focus on long-term earnings: Goldman Sachs maintains its 2026–2027 forecasts, while cutting its 2028 and 2029 revenue forecasts by 2% and 1%, respectively, and its net profit forecasts by 14% and 7%, respectively. The changes mainly reflect more conservative assumptions for average selling prices of advanced processes.
  • Goldman Sachs still expects average selling prices for advanced processes to rise year on year as AI demand grows and the product mix shifts toward higher-end offerings. However, the gradual ramp-up of new capacity and a broader product and customer mix make the pace of price increases slower than previously expected. The demand-growth thesis remains intact, but the expected pace of improvement in revenue per unit has been reduced.

How does AI drive both advanced and mature processes?

  • The link to advanced processes is domestically produced AI chips: expansion of China’s AI chip market is expected to increase demand for SMIC’s advanced processes. Mature processes gain demand support from AI-related analog chips and power semiconductors, so the benefits extend beyond computing chips.
  • Another avenue comes from the allocation of global foundry capacity: as major international foundries devote more capacity to AI and leading-edge processes, Chinese foundries have an opportunity to take on non-AI and mature-process demand. Goldman Sachs also cites domestic substitution, customers diversifying their suppliers, and SMIC’s capacity expansion as supports for growth.

Can capacity expansion translate smoothly into profit?

  • Capacity expansion increases the ability to accommodate revenue growth but also brings higher depreciation. Goldman Sachs expects high capacity utilization and improving average selling prices to only partly offset depreciation pressure from new capacity, so revenue expansion and improvements in profitability do not occur in lockstep.
  • The revised 2028 revenue forecast is US$18.009 billion; the gross margin forecast falls from 29.1% to 27.5%, and the expense ratio is raised by a further 0.3 percentage points. Net profit falls from US$2.579 billion to US$2.219 billion. Revenue is cut only slightly, but the changes in gross margin and the expense ratio substantially magnify the profit reduction.
  • This growth path also depends on product diversification and the progress of capacity expansion. Constraints cited by Goldman Sachs include weaker-than-expected demand for smartphones and consumer electronics, and potential restrictions on supplies of some equipment and materials following SMIC’s inclusion on the US BIS Entity List.

Why is the target price unchanged after the profit forecast cuts?

  • Goldman Sachs maintains its buy rating and 12-month Hong Kong share target price of HK$153, while rolling its valuation basis forward from 2028 to 2029. It previously used 80.7 times forecast 2028 earnings; it now uses 66.7 times forecast 2029 earnings, discounted back to 2027 at a cost of equity of 15%.
  • Rolling the valuation year forward uses a higher earnings base: Goldman Sachs forecasts 2029 net profit of US$3.123 billion, above the US$2.219 billion forecast for 2028. The unchanged target price reflects the combined effect of the earnings cuts and the valuation roll-forward.
  • The 12-month A-share target price remains RMB257.9, continuing to apply a 196% valuation premium over the H shares. The premium is based on SMIC’s average A/H valuation gap since January 2024.