Event: 2Q24 achieved revenue of $0.479 billion, down 24% year on year and 4% month-on-month, slightly higher than the lower limit of the company's guidance range of $0.47-0.5 billion, and lower than market expectations of $0.486 billion. In terms of wafer size, revenue from the 8-inch production line was 0.245 billion US dollars, down 32% year on year, up 2% month on month; revenue from the 12-inch production line was 0.233 billion US dollars, down 14% year on year, up 6% month on month. In terms of profit, gross margin exceeded expectations, and net profit was under pressure due to increased operating expenses. The 2Q24 gross profit margin was 10.5%, higher than the upper limit of 6%-10% in the guideline range. It was higher than the 9.1% market forecast. The year-on-year decrease of 17.2 pct was a year-on-year decrease in ASP; the month-on-month increase of 4.1 pct was an increase in capacity utilization. Net profit for 2Q24 was 6.67 million US dollars, down 91.5% year on year, down 79% month on month, lower than market expectations of 15.3 million dollars.

There are signs of a steady recovery in market demand. Capacity utilization is at full capacity. Wafer prices will rise after ASP 2Q24 bottoms out, so we are optimistic about subsequent gross margin performance. 1) Overall downstream demand is improving, with 2Q24 increasing downstream demand in fields such as logic, radio frequency, power management ICs (especially BCD) and CIS; in the non-volatile memory sector, demand for products such as MCUs and smart card chips is showing signs of recovery; however, demand in the IGBT market is weak, and the company expects 2H24 to improve. 2) The recovery in capacity utilization rate led to an increase in shipment volume. 2Q24 wafer shipments (equivalent to 8 inches) were 1.106 million pieces, up 3% year on year and 8% month on month. The month-on-month increase in 2Q wafer shipments offset the 4% month-on-month decline in ASP. The overall capacity utilization rate in 2Q was 97.9%, down 4.8pct year on year, and 6.2pct month-on-month. Capacity utilization rates for 8 inch and 12 inch increased slightly from 100.3%/84.2% in 1Q to 107.6%/89.3%, respectively. Based on the gradual recovery of downstream demand, the company's guidance of 95% + capacity utilization will continue until at least 2025. Increased capacity utilization helped 2Q24 gross margin exceed expectations, and laid the foundation for a gradual increase in 3Q24 ASP prices.

The 3Q24 guidelines are relatively moderate and conservative. I am optimistic that the trend of increasing ASP and thus boosting gross margin will be stronger in 24Q4 and 2025. The company guided 3Q24 revenue of 0.5-0.52 billion US dollars, lower than market expectations of 0.525 billion US dollars. The median value corresponds to a 6.6% month-on-month increase, of which 70% was driven by ASP increase and 30% was driven by shipment growth; the company guided 3Q24 gross profit margin of 10%-12%, with a median increase of 0.5 pct month-on-month, lower than market expectations of 13.6%. ASP's price increase trend is slightly slower than expected. We think it is mainly because market demand has not fully recovered. It is expected that 4Q24 will increase ASP and increase gross margin even more significantly in 4Q24 and 2025 as demand in segments such as MCU and IGBT improves.

Huahong Manufacturing's new production line will release production capacity in 2025. The construction of the company's second 12-inch production line, Huahong Manufacturing, is actively progressing. It is expected to enter the trial production stage by the end of 24, and to release 0.02 million pieces/month of production capacity by the end of 25, further improving shipping capacity, but increased depreciation and amortization will put pressure on gross margin. We believe that a significant price increase for wafer ASP in 25/26 will effectively offset the negative impact of depreciation and amortization on gross margin.

Profit forecasting, valuation and rating: The company's characteristic process has technical advantages. The downstream boom is showing signs of steady recovery, and the wafer ASP is about to start price increases. However, considering the increase in operating expenses affecting the company's net profit, the net profit forecast for 24-26 was lowered to 0.108/0.207/0.262 billion US dollars (-50%/-29%/-34% compared to the previous forecast), corresponding to the year-on-year growth rate of -61%/+91%/+27%.

The current stock price of HK$18.08 corresponds to 24/25 37x/19x PE, corresponding to 24/25 0.6x/0.6x PB. The PB valuation is historically low and has a margin of safety. It is optimistic that the semiconductor cycle recovery will drive wafer ASP price increases, thereby helping the company recover its fundamentals quarterly and maintain a “buy” rating.

Risk warning: The semiconductor boom continues to decline; the company's production expansion progress falls short of expectations; competition intensifies risks.