Summary of Hua Hong Semiconductor Conference Call Company Overview - **Company**: Hua Hong Semiconductor - **Sector**: Semiconductors - **Focus**: Pure foundry primarily engaged in 200mm and 300mm wafer processing, specializing in semiconductors for specialty applications such as embedded non-volatile memory (eNVM) and power discrete [12][13] Key Points and Arguments Downgrade and Price Objective - **Rating Change**: Downgraded from Buy to Underperform due to cautious outlook on wafer ASP and margin recovery in 2026 [1][3] - **New Price Objective**: HK$59, based on a 2x P/B (2026E), reflecting a more conservative valuation compared to the previous HK$44.5 [3][44] Inventory and Demand Dynamics - **Inventory Pressure**: Rising inventory levels among China's semiconductor chipmakers are expected to limit ASP increases in 2026, with a revised assumption of 5% ASP growth (down from 10%) [2][16] - **Demand Growth**: Chip shipment growth in China has slowed significantly, with 0%/11%/6% YoY growth in June/July/August 2025, compared to 16-40% YoY in the previous periods [2][15] Financial Forecasts - **Profitability Outlook**: Estimated operating profit margin (OPM) of 4% in 2026, improving from -4% in 2025 but below the 10-year average of 10% [2][31] - **Net Income Projections**: Adjusted net income forecast for 2026 is US$216 million, with a gradual recovery expected in subsequent years [4][42] Capacity Expansion and Acquisitions - **Acquisition of Huali Micro**: Plans to acquire Huali Micro (Fab5) announced, but details are pending. This acquisition is expected to enhance long-term competitiveness by increasing revenue and capacity [1][3] - **Capacity Growth**: Completion of Fab9 in 2026 could increase total 12" wafer capacity by 38%, with total wafer shipment expected to grow by 26% in 2026 [31][37] Market Position and Valuation - **Market Share Risks**: Aggressive capacity expansion by competitors like SMIC poses downside risks to Hua Hong's market share and profitability [3][13] - **Valuation Comparison**: Hua Hong's current P/B of 2.6x (2026E) is higher than the average of 3.2x for China foundry/OSATs, indicating a rich valuation [60] Cash Flow and Capital Expenditure - **Free Cash Flow**: Negative free cash flow expected due to high capital expenditures for Fab9 construction, projected at US$2-3 billion per year [45][46] - **Operating Cash Flow**: Operating cash inflow is expected to remain below US$1.5 billion, leading to negative free cash flow in the near term [45][46] Additional Important Insights - **Sales Mix**: Sales exposure to overseas markets has decreased from over 40% in 2017-2019 to less than 20% by 2024, indicating a shift towards domestic markets [42] - **ASP and Margin Trends**: Wafer ASP stabilization is anticipated in 1H25, but overall margins are expected to remain below 20% by the end of 2026 due to inventory pressures [39][40] This summary encapsulates the critical insights from the conference call regarding Hua Hong Semiconductor's current position, challenges, and future outlook in the semiconductor industry.