Hua Hong Semi:China 200mm beneficiary

Hua Hong posted good 1Q15 results with in-line 2Q15 guidance. Thecompany focuses on niche applications such as bank cards, SIM cards andpower-management IC. With low exposure to smartphones and highexposure to rapidly rising China-based fabless companies, together withhealthy 8-inch supply/demand, Hua Hong Semi is on track to deliver10.2%/21.1% earnings growth in 15/16CT. We transfer coverage with aBUY rating. Our new target price of HK$12.86 (from HK$11.66) implies27% upside.

Good results

Hua Hong reported a good set of results. Revenue remained flattish QoQ in1Q15 thanks to strong demand for smart cards and power-discrete devices.GM also improved, from 29.1% in 4Q14 to 30.5% in 1Q15, boosted by ahigher utilisation rate. Combined with lower opex, overall earnings came in7% higher than our expectation. Revenue from China expanded from 52.6%in 4Q14 to 56.5% in 1Q15 and the company expects China to remain the keygrowth driver. Capacity is also on track to expand by 13% by year end.

In-line guidance

Hua Hong guides revenue to grow by 2% QoQ with flattish GM in 2Q15.Management remains upbeat on 200mm industry supply-demand conditionsand suggested it is proceeding with its capacity expansion plan to meetcustomer needs. We believe the stronger-than-peers’ revenue guidance in 2Q(versus Vanguard at -2-5% QoQ) is due to higher exposure to domesticdemand in China, lower exposure to smartphones and Vanguard customers’inventory pre-builds in 4Q14/1Q15.

Capacity expansion

Management expects depreciation to rise by 34% in 2016 and furtherincrease 30-40% YoY in 2017 due to aggressive capex. This is a much steeperincrease than we expected. Nevertheless, we believe the company will rampup 90nm/110nm (bank cards), which carry higher margins to offset theimpact.

Transfer coverage with BUY

We transfer coverage with a BUY rating as Hua Hong is our preferred play tomonetise the Chinese government’s semiconductor subsidy program. Our newtarget price of HK$12.86 (previously HK$11.66), based on 1x 16CT bookvalue per share (versus 0.9x earlier), implies 27% upside.