Hua Hong Semi:Stronger than the competition

Share-gain upside and higher guidance than peers.

Hua Hong reported good 2Q15 results and better guidance than peers.

Despite muted demand for semiconductors, diversified and expandingapplications and an improving customer profile should support solidearnings growth. We maintain BUY with an unchanged target price ofHK$12.86, based on 1x 16CT PB, for 63% implied upside.

Good results.

Hua Hong reported good results 2Q15 results - impressive given the weakenvironment of late. Revenue grew 4% QoQ thanks to strong demand formicrocontrollers (MCU) which offset the negative impact from smart cards.

Gross margin improved significantly, from 30.5% in 1Q15 to 33.0% in 2Q15,boosted by a higher utilisation rate. Opex was up, but operating profit was inline with our forecast. With lower tax, overall earnings came in 23% higherthan we expected. Capex remained unchanged and capacity is on track toexpand 13% by year end.

Lower guidance but better than peers.

The company is guiding revenue to be flat in 3Q15. Despite lower thanpreviously forecast, it is still much stronger than peers’ revenue guidance in3Q (versus Vanguard’s 10-15% QoQ decline) due to market-share gains inMCU, lower exposure to smartphones and inventory prebuilds by Vanguard’scustomers. Gross margins will contract 3-4ppts to 28-29%, lower than ourforecast of 30%, due to a lower production utilisation rate and higherdepreciation costs.

Market-share gains.

Hua Hong is a relatively small player in the foundry industry. Market-sharegains, together with local Chinese customers, are the key earnings drivers.

Diversification into new applications (LED lighting, sensors) will provideadditional growth engines.

Maintain BUY.

The stock has underperformed the Index by 20%, largely due to investorconcerns over weaker semiconductor demand. With diversified applications,constrained industry-capacity growth, and an improved customer profile, weexpect Hua Hong to deliver stronger growth than peers. We maintain BUYwith an unchanged target price of HK$12.86, based on 1x 16CT PB, implying63% upside.