2Q26 guidance surprises to the upside; Morgan Stanley maintains SMIC Overweight view

Overview

This report is Morgan Stanley's company research update on SMIC, with a core focus on 1Q26 results and 2Q26 operating guidance. The report argues that SMIC's 1Q26 revenue was in line with expectations and gross margin was better than expected, while 2Q26 revenue and gross-margin guidance further beat market expectations. The analyst maintains a positive view on the company, believing SMIC holds a key position in China's domestic AI GPU supply chain, while high utilization and rising ASP help offset the incremental depreciation pressure from ongoing capacity expansion.

Core views

The core views are: first, 1Q26 revenue was US$2.51bn, up 1% qoq and 11% yoy, mainly driven by higher blended ASP; second, 1Q26 gross margin was 20.1%, up 0.9 percentage points qoq and better than expected; third, 2Q26 revenue guidance of 14%-16% qoq growth and gross-margin guidance of 20%-22% indicate strong demand, shipments, and pricing; fourth, despite 1Q26 net profit attributable to shareholders of US$197mn, up 14% qoq, it fell below expectations because government subsidies were lower; fifth, Morgan Stanley maintains an Overweight rating and believes the company still has medium-term support from China's domestic AI GPU supply chain and the capacity expansion cycle.

Analysis framework

The report combines earnings tracking, operating-guidance interpretation, and valuation modeling: it first compares 1Q26 revenue, gross margin, and net profit against Morgan Stanley and consensus expectations, then analyzes the drivers behind 2Q26 guidance for revenue, shipments, ASP, and gross margin, and finally uses a residual income model to assess the target price while discussing upside and downside risks in light of semiconductor demand, competitive landscape, utilization, product mix, and ASP trends.

Methodology notes

• Valuation methodsResidual income model

  residual income model

  Morgan Stanley uses a base-case residual income model for valuation, with key assumptions including an 8.6% cost of equity, beta of 1.2, a 2% risk-free rate, a 5.5% risk premium, 16% mid-cycle growth, 5% terminal growth, and an 84% cash dividend payout ratio.

• forecastingMorgan Stanley ModelWare

  Morgan Stanley's internal forecasting framework

  The report states that, unless otherwise noted, the relevant figures are based on the Morgan Stanley ModelWare framework; some data use consensus methodology or Refinitiv Estimates.

• rating_definitionOverweight rating framework

  relative rating system

  Morgan Stanley's Overweight means that over the next 12-18 months, the risk-adjusted expected total return on the stock is expected to exceed the average total return across the analyst's industry coverage universe, and it is not equivalent to a traditional Buy rating.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• SMIC 0981.HK

  research subject and core equity asset

  Strengths

  2Q26 revenue and gross-margin guidance are stronger than expected, with high utilization, rising ASP, and a role in the domestic AI GPU supply chain as the main supports.

  Weaknesses

  1Q26 net profit attributable to shareholders fell below expectations due to lower government subsidies; continued capacity expansion will add further depreciation pressure.

  Comparison

  The report uses Morgan Stanley's relative rating framework, where Overweight means the expected total return over the next 12-18 months should be above the average across the covered industry universe.

  Risks

  Weakening semiconductor demand, intensifying price competition, utilization and product mix coming in below expectations, and uncertainties related to export controls.

Key data

• 1Q26 revenueUS$2.51bnUp 1% qoq and 11% yoy, broadly in line with Morgan Stanley and consensus expectations, mainly driven by higher blended ASP.
• 1Q26 gross margin20.1%Up 0.9 percentage points qoq, above Morgan Stanley and consensus expectations.
• 1Q26 net profit attributable to shareholdersUS$197mnUp 14% qoq, but below Morgan Stanley and consensus expectations because 1Q government subsidies were lower.
• 2Q26 revenue guidance14%-16% qoq growthDriven by about 10% shipment growth and about 5% price increases.
• 2Q26 gross margin guidance20%-22%Based on the midpoint of the range, this implies about 0.9 percentage points of sequential improvement.
• Target priceHK$70.00Against the May 14 closing price of HK$71.50, this implies about -2% downside.
• 2026e revenue forecastUS$10.908bnThe financial forecast table shows revenue expected to rise from US$9.327bn in 2025 to US$13.690bn in 2028e.
• 2026e ModelWare net profitUS$1.492bnThe forecast table shows ModelWare net profit expected to increase from US$685mn in 2025 to US$2.622bn in 2028e.

Impact & implications

The report's investment implication for SMIC is positive: 2Q26 guidance shows strong demand, pricing, and utilization, which should help the market raise near-term earnings expectations. If the company can sustain high utilization and continue improving product mix, the additional depreciation pressure from capacity expansion may be absorbed. That said, the current closing price is already slightly above the target price, so near-term valuation upside is limited; future share performance will therefore depend more on earnings upgrades, execution in the domestic AI GPU supply chain, and the sustainability of industry conditions.

Risks

• Weakening global and China semiconductor demand.
• Intensifying price competition that erodes margins.
• Utilization, product mix, and ASP trends coming in below expectations.
• Depreciation pressure from ongoing capacity expansion may weigh on earnings if it cannot be offset by high utilization and higher ASP.
• The report mentions export controls and related entity restrictions; investment or trading activity must comply with applicable laws.

What to watch

• Whether actual 2Q26 revenue reaches the guided 14%-16% qoq growth range.
• Whether 2Q26 gross margin stays within the 20%-22% range and continues to improve sequentially.
• Whether the roughly 10% qoq shipment growth and roughly 5% qoq ASP improvement are realized.
• The strength of demand from China's domestic AI GPU supply chain in supporting SMIC's utilization and product mix.
• Subsequent changes in government subsidies and their impact on net profit.
• Changes in price competition, industry supply-demand balance, and peers' capital expenditure.