Reiterating Huahong's “buy” rating: Huahong's gross margin reached 6.4% in the first quarter, which was higher than the upper limit of the company's guidance range and superior to market expectations. The company indicates that the median gross margin for the second quarter will reach 8%, continuing to improve on the basis of the first quarter. This is in line with our judgment on the fundamental cycle of the semiconductor foundry industry, that is, China's semiconductor fundamentals cycle is in an upward phase this year.
According to research, in addition to the fact that high voltage power devices such as IGBTs are still under price pressure, the boom in products such as BCDs, storage, and image sensors is on the rise. Therefore, we are optimistic that the company's fundamentals will continue to improve in the second half of this year. In the long run, Huahong's 12-inch factory in Wuxi is progressing as scheduled.
The company expects equipment to be moved in September, and trial operation is expected to begin in the fourth quarter of this year, and production capacity is expected to be released in 2025. Currently, Huahong's 2024 and 2025 EV/EBITDA valuations are 5.7x and 3.6x. The valuation is already attractive, maintaining the “buy” rating and the semiconductor industry's first choice.
The gross margin for the first quarter exceeded expectations, and the gross margin for the second quarter continued to improve: Huahong's revenue in the first quarter fell 27% year on year. The year-on-year growth rate was roughly comparable to -28% in the fourth quarter of last year, but Huahong's gross margin reached 6.4%, which improved from 4.0% in the fourth quarter of last year, exceeding our expectations. Furthermore, the company's gross margin for the second quarter is expected to further improve to the median guideline of 8%.
Among them, the popularity of products such as image sensors, power management, storage, and low-voltage power devices has all bottomed out to varying degrees. As a result, the company's 8-inch and 12-inch production capacity utilization increased sequentially in the first quarter. Although the average price of the company's wafers declined month-on-month, according to our estimates, the price of 12-inch wafers is already showing signs of bottoming out and rising. We expect the company's operating margin for the next three quarters to continue to improve on the basis of -16.9% in the fourth quarter of last year and -10.6% in the first quarter of this year, driving the growth of the company's EBITDA.
Valuation: Based on Huahong's first quarter results and second quarter guidance, we have slightly adjusted Huahong's profit forecast. We maintain Huahong's target EV/EBITDA estimate of 8.5x in 2024. The target price for Huahong Hong Kong shares is HK$20.6, with a potential increase of 21%. The target price for Huahong A shares is RMB 43.6, a potential increase of 35%.
Investment risk: Downstream demand in the semiconductor industry (smart phones, new energy vehicles, industry, etc.) is recovering slowly, dragging down the company's performance growth and affecting the momentum of a rebound in valuation. Utilization rates continue to decline due to new production capacity in foundry manufacturing. Competition in the industry has intensified, hampering profit performance.