Hua Hong Semiconductor Ltd.Above expectations:MCU and smartphone drive upside

What surprised us

Hua Hong reported 4Q16 revenue and EPS of US$194.0mn and US$0.04,above GHe of US$185.3mn and US$0.02, respectively, mainly due tohigher wafer shipment and profit from associate. The company guidedrevenue to be between US$182-US$183mn, and GPM of c.29% in 1Q17,above GHe of US$177mn and 27%, respectively, due to healthy demand inMCU and smart card ICs and improving product mix. Highlights: (1) HuaHong saw solid growth in the eNVM segment in 4Q16 due to strongdemand from MCU products and smart card ICs. Revenue from discreteswas also healthy on increased demand for MOSFET products. Weakness inthe analog and PMIC segment was primarily due to weak demand for LEDlighting products. (2) Hua Hong expects demand to be strong in mostsegments with emphasis on MCU, smart card IC, and super junction. Itexpects ASP to trend flat to up due to its node migration, but sees possiblepressure on GPM due to increase in D&A. (3) As per Hua Hong, it islooking to capture organic growth opportunities in MCU and bank card ICby adding 10K-12K capacity in Fab-3 by end-2017. Hua Hong guided 2017capex of US$200mn, above GHe of US$90mn (prior) due to capacityexpansion in Fab-3 and upgrade at Fab-2 and Fab-1.

What to do with the stock

We view Hua Hong’s 4Q16 results as positive and continue to believe thatits shares offer steady growth at low valuation. Based on this, we raise our2017E-2018E earnings by 5%. Our 12-m TP rises by 9.5% to HK$11.5 as weroll over. It is based on 85% fundamental value (prior 0.83x FY16E P/B tonow 0.96x FY17E P/B to NTM BVPS) and 15% M&A value (21% premium tofundamental PBR, derived from historical global semiconductor deals).

Remain Buy. Key risks: Higher-than-expected cost with capacity ramp.