Hua Hong's 4Q23 results were broadly in line while new capacity added at Wuxi Fab7 ahead of schedule weighed on 1Q24 UTR and GPM outlook. We remain positive on semiconductor market recovery in 2024 and Hua Hong's order momentum driven by domestic clients and new products to digest the new capacity. Hua Hong remains an attractive stock to us with 0.5x P/B and US$3.7bn net cash position. We rate Hua Hong BUY with HK$23.5 TP, based on 0.82x P/B (was 0.85x).
Key Factors for Rating
4Q23 financials: Revenue decreased by 28% YoY and 20% QoQ to US$455m, at the low end of guidance, due to slow MCU and power discrete demand. GPM declined by 12.1ppts QoQ to 4.0%, at the higher end of guidance. OPM recorded -16.8%, due to decrease in government grants for R&D and increasing engineering wafer costs and labour expenses of Wuxi Fab9. NI was US$35m, beating BOCIe and consensus due to the increase of government subsidy and forex gain.
Semiconductor on recovery: Mgmt. saw market and order book recovery recently thanks to the end of destocking and rapid growth in new IoT, AI and smartphone products. CIS and PMIC have been strong since 4Q23 while power electronics and MCU started to bottom out. We believe from a sequentially perspective, Company's operating matrix will continue improving.
2024 guidance: 1Q24 GPM guidance is still weak but it is mainly due to the capacity expansion of Wuxi Fab7 ahead of schedule and increasing D&A. Thanks to stronger demand, ASP has been stable in 1Q24. Mgmt's current strategy is to ramp UTR to above 95% as quickly as possible before considering further room to lift ASP and margins.
Key Risks for Rating
US-Sino relationship; intensifying mature node price competition; faster-than- expected product migration to advanced node; macro and end demand risk.
Valuation
We derive our new HK$23.5 target price based on 0.82x P/B, -1sd below its five year average multiple of 1.5x. Our target price represents 87x/17x/8x 2024E/25E/26E EPS.
We believe the current share price of Hua Hong at 0.5x P/B with more than US$3.7bn net cash position offers high downside risk protection after the recent sell-off. We believe it is a good time to accumulate at a low valuation when the semiconductor industry starts the recovery trajectory.