CSCI-Semiconductor-Hua Hong Semiconductor (1347 HK)：Still at the beginning of harvest period-20171108

Still at the beginning of harvest period

• Hua Hong Semi (HHS) reported record high revenue, gross margin and gross profit for the second consecutive quarter, with pre-tax profit at a record high in 3Q17.
• With revenues almost tripled in both 2Q17 and 3Q17 from industrial and automotive industries, HHS is well poised to ride on the upsurge in ‘made-in-China’ upgrade and electric-car push in China.
• We have revised up our FY17/18/19E earnings forecasts by 1.0%/4.7%/6.4% respectively and raised our DCF-based price target to HKD18.0 for end-2018 (from HKD12.8 for end-2017). Maintain Buy.

A second quarter with record high revenue and gross margin. HHS reported record high revenue, gross margin and gross profit for the second consecutive quarter in 3Q17, with pre-tax profit at a record high, which we believe was attributable to 1) a high utilisation (97.8% in 3Q17) on strong order book, 2) stable capex and R&D spending (focusing on 8-inch), and 3) enhanced economies of scale. Management guided a 3% QoQ revenue growth and gross margin of 33-34% for 4Q17, with the continuous revenue growth suggesting that there will be no year-end production suspension. In spite of its efforts to add capacity (c.10% a year in our estimates), HHS will continue to come under supply constraints over the next 2-3 years.

Right products for right markets and industries. By technology nodes and manufacturing platforms, HHS’ strong 3Q17 revenue growth was across the board. But interestingly to note, by industries, HHS’ products appear to have catered well for the right markets and industries like consumer electronics, industrial and automotive. In particular, HHS has almost tripled the revenues from the industrial and automotive segments, both with promising long-term growth potential amid ‘made-in-China’ upgrade and the electric-car push.

12-inch on the cards. Though nothing definitive at the moment, management’s response to questions relating to 12-inch hinted at the progress in the company’s long-term strategy to foray into the 12-inch market, most likely through acquisition of the 12-inch business from its parent company, in our view.

Re-rating still half-way. On the back of higher shipments and ASP, we nudged up our FY17/18/19E revenue and net profit forecasts by 3.3%/4.1%/6.2% and 1.0%/4.7%/6.4% respectively, which led us to revise up our DCF-based price target to HKD18.0 for end-2018 (from HKD12.8 for end-2017), implying 22.3% potential upside. Trading at FY18E 10.8x PER and 1.0x PBR, HHS’ current valuation still looks attractive compared with its bigger global and domestic peers. Maintain Buy.