SMIC 2Q26 guidance surprised to the upside, Morgan Stanley maintains Overweight

Overview

This is a company research update on SMIC (0981.HK). The key message is that 1Q26 revenue was in line with expectations, gross margin was better than expected, and 2Q26 revenue and gross margin guidance were materially stronger than market expectations. Morgan Stanley maintains Overweight, arguing that the company is an important participant in China's domestic AI GPU supply chain and that, with utilization staying high and ASP rising, it can absorb the incremental depreciation pressure from continued capacity expansion.

Core views

The report's core views are: first, 1Q26 gross margin and 2Q26 guidance show strong operating momentum; second, 2Q revenue growth is driven by both shipment volume and pricing rather than volume alone; third, the company's strategic position in China's semiconductor localization and domestic AI GPU supply chain supports the medium-term investment case; fourth, the current target price of HK$70.00 is slightly below the report-referenced closing price of HK$71.50, but the relative rating remains Overweight, emphasizing risk-adjusted return expectations versus the analyst's covered universe.

Analysis framework

The report combines quarterly results, company guidance, earnings forecasts, valuation models, and risk scenarios. On the operating side, it focuses on revenue, gross margin, net profit attributable to shareholders, utilization, product mix, and ASP. On valuation, it uses a residual income model and provides key assumptions such as cost of capital, growth rate, and payout ratio. On risks, it lays out upside and downside drivers separately.

Methodology notes

• Valuation methodsResidual income model

  residual income model

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

• rating_systemmorgan_stanley_relative_rating

  relative rating framework

  Morgan Stanley's Overweight means the risk-adjusted expected total return on the stock over the next 12-18 months is above the average total return of the analyst's covered universe, and it is not the same as a traditional outright buy recommendation.

• forecastingmodelware_estimates

  Morgan Stanley ModelWare forecasting framework

  Unless otherwise stated, the report's main financial metrics are based on Morgan Stanley ModelWare, and some data also incorporate consensus estimates or Refinitiv Estimates.

Asset mapping & comparison

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

• SMIC 0981.HK

  report coverage subject

  Strengths

  Strong 2Q26 revenue and gross margin guidance; 1Q26 gross margin beat expectations; high utilization and rising ASP; key position in China's domestic AI GPU supply chain.

  Weaknesses

  1Q26 net profit attributable to shareholders missed expectations because government subsidies were lower; continued capacity expansion will bring additional depreciation pressure; free cash flow yield remains negative in 2025-2027e.

  Comparison

  Relative to the Greater China semiconductor coverage universe, Morgan Stanley assigns Overweight and an Attractive industry view; rating history shows the target price has been raised materially since 2024, but the latest target price is HK$70.00.

  Risks

  Weaker semiconductor demand, intensified price competition, utilization or product mix below expectations, weaker-than-expected ASP trends, export controls and related compliance restrictions.

Key data

• 1Q26 revenueUS$2.51bnUp 1% QoQ and 11% YoY, in line with Morgan Stanley and consensus.
• 1Q26 gross margin20.1%Up 0.9 percentage points QoQ, above Morgan Stanley and consensus.
• 1Q26 net profit attributable to shareholdersUS$197mnUp 14% QoQ, but below Morgan Stanley and consensus because government subsidies were lower.
• 2Q26 revenue guidanceUp 14%-16% QoQDriven by about 10% shipment growth and about 5% price increases.
• 2Q26 gross margin guidance20%-22%At the midpoint, about 0.9 percentage points higher QoQ.
• RatingOverweightRating maintained.
• Target priceHK$70.00Target price shown in the report table.
• Closing priceHK$71.50As of May 14, 2026.
• 2026e revenue forecastUS$10,908mn2026e revenue shown in the financial forecast table.
• 2026e adjusted EPSUS$0.1582026e adjusted EPS shown in the financial forecast table.

Impact & implications

If 2Q26 guidance is delivered, SMIC's revenue growth, gross margin resilience, and earnings recovery will be further validated. In terms of investment implication, the report places greater emphasis on the company's strategic position in the domestic semiconductor supply chain, utilization improvement, and ASP increases, while near-term valuation upside appears limited. Because the target price is slightly below the report-referenced closing price, the investment view needs to be understood within Morgan Stanley's relative rating framework, rather than interpreted simply as absolute upside to the target price.

Risks

• Global and China semiconductor demand weaker than expected.
• Intensifying price competition erodes margins.
• Utilization, product mix, and ASP trends fall short of expectations.
• Additional depreciation from capacity expansion may exceed the absorption capacity of operating improvement.
• The report mentions export controls and entities that may be subject to export controls; related investment or trading activity must comply with applicable laws.
• Morgan Stanley discloses that it may have business relationships with the covered company; investors should treat the research as only one factor in investment decisions.

What to watch

• Whether the 2Q26 revenue guidance of 14%-16% QoQ growth is delivered.
• Whether 2Q26 gross margin lands in the 20%-22% range and whether midpoint QoQ improvement is achieved.
• The actual split between about 10% QoQ shipment growth and about 5% QoQ price increases.
• Whether utilization, product mix, and ASP continue to outperform expectations.
• Demand in China's domestic AI GPU supply chain and the pace of localization progress.
• The impact of capacity-expansion depreciation pressure on earnings and cash flow.
• Changes in the global and China semiconductor demand cycle and price competition.