Hua Hong Semiconductor (HKG: 1347) shares are down 15% today. One part of this is simply that the announced results were not good: “HUA HONG's 3Q net profit was US$13.89 million, cratering 86.6% YoY, with a gross margin of 16.1%, which was in line with guidance but down 21.1 ppts YoY.” That’s not the sort of thing we want to see in a semiconductor fab’s results.
It’s worth a think through the economics of such fabs. The raw material, sand, is pretty cheap. Sure, that has to be made up into silicon ingot and so on but that’s still only in the $20 to $30 a kg range. It’s what is then done to make the chips which is the value add. However, it costs billions to build the factory that can do that work to add that value. The effect of this is that the profit margin almost entirely relies upon capacity utilisation. Run the fab at 80% of capacity (purely a made up number for illustration) and 95% and more (again, made up number) of the costs still have to be paid - the costs of having built the factory in the first place. Run the same fab at 100% and it’s wildly profitable - the extra costs for the extra silicon are negligible as compared to the extra revenue.
Silicon fabs live off capacity utilisation. That’s the point to grasp.
Hua Hong Semiconductor share price from Google Finance
Which brings us to the second reason for this price fall. Capacity utilisation rates are falling right across the Far East’s fabs. At least those not working on the very latest and fastest chips. “China's SMIC (0981.HK) on Friday shrugged off a more than 70% drop in net third-quarter profit, saying it expected Chinese semiconductor demand to stabilise soon, and increased its annual capital expenditure forecast to about $7.5 billion.” Note that “stabilise soon” means “has not stabilised yet”. We’ve talked before of SMIC of course. We’re seeing the same with AEM SG, a supplier to this market out of Singapore. And we’ve touched on Hua Hong here and here.
What appears to be happening is a general slowdown in the semiconductor market. Of course this is bad for semiconductor stocks.
