Mature-Node Foundry Recovery: Maintain Buy on SMIC and Hua Hong; Target Prices Raised

Overview

Citigroup believes SMIC's and Hua Hong's 2Q26 results and 3Q outlook confirm that China's mature-node and specialty-process foundry market is entering a more constructive recovery phase. The recovery is driven not only by AI accelerators themselves, but also by AI hardware demand spillover into PMICs, MCUs, BCD, power devices, connectivity, and peripheral logic, as well as China localization trends.

Core views

Industry capacity utilization is already at high levels, while supply continues to lag demand. Stronger pricing negotiations and higher ASPs are reinforcing shipment recovery and generating meaningful operating leverage. Hua Hong is showing notable growth in embedded NVM/MCU, standalone NVM/flash, logic/RF, and analog/PMIC; SMIC benefits from local customers' AI-related demand, flexible capacity allocation, and accelerating new-capacity qualification.

Analysis framework

Based on both companies' 2Q26 actual results versus market expectations and prior guidance, 3Q26 management guidance, capacity utilization and capital expenditure, product demand mix, ASP and gross-margin trends, as well as valuation using 2026/2027 book value and price-to-book ratios.

Methodology notes

• Valuation methodsPrice-to-book valuation

  Target prices are estimated by applying forward P/B multiples to average 2026/2027 book value per share.

  SMIC uses 4x P/B and Hua Hong uses 5x P/B, both approximately two standard deviations above the average of their respective historical P/B ranges, reflecting expectations for improved demand, pricing, and capacity utilization.

• Operating analysisCapacity utilization and operating leverage

  High capacity utilization combined with higher ASPs can amplify gross-margin and profit improvement.

  The report incorporates utilization, pricing, product mix, and depreciation from new capacity into its earnings forecast revisions.

Asset mapping & comparison

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

• SMIC (0981.HK)

  China's leading wafer foundry, benefiting from localization, AI-related demand, and capacity demand across mature and advanced nodes.

  Strengths

  Significant improvements in 2Q26 revenue, gross margin, and utilization; flexible production-line allocation capability; leading technology and scale in China's foundry sector.

  Weaknesses

  Advanced-node ramp-up and R&D investment may increase depreciation and expense pressure.

  Comparison

  Compared with Hua Hong, SMIC has broader 8-inch and 12-inch manufacturing capabilities and a stronger advanced-node position; valuation uses 4x average 2026/2027 P/B.

  Risks

  ASP competition or lower-than-expected yields, high depreciation burden, weaker end demand, reduced policy support, and a temporary slowdown in localization trends.

• Hua Hong Grace Semiconductor (1347.HK)

  A Chinese specialty-process foundry, principally benefiting from demand for MCUs, eNVM, flash, power devices, analog products, and PMICs.

  Strengths

  Its specialty-process product mix aligns with AI hardware demand spillover; achieved record revenue in 2Q26; high capacity utilization and improving ASPs support earnings recovery.

  Weaknesses

  The capacity-expansion cycle is relatively long, with meaningful output from new 12-inch capacity mainly reflected from 4Q26 and in 2027.

  Comparison

  Compared with SMIC, Hua Hong is more focused on 8-inch and mature 12-inch specialty processes; valuation uses 5x average 2026/2027 P/B.

  Risks

  Lower-than-expected China semiconductor demand, greater-than-expected peer capacity expansion in 8-inch and mature 12-inch nodes, and a weakening global macroeconomy.

Key data

• SMIC 2Q26 revenueUS$3.006bn+20% QoQ, +36% YoY, around 5% above Citigroup and market expectations.
• SMIC 2Q26 gross margin and utilization25.3%; 93.7%Gross margin improved by 5.2 percentage points from 1Q26; 3Q26 gross-margin guidance is 26% to 28%.
• SMIC 3Q26 guidanceRevenue +2% to +4% QoQManagement expects AI industrial-demand spillover to continue in 2H26.
• Hua Hong 2Q26 revenueUS$718mn+9% QoQ, +27% YoY, representing record quarterly revenue.
• Hua Hong 2Q26 gross margin16.5%Supported by higher shipment volumes and improved ASPs.
• Hua Hong 3Q26 guidanceUS$770mn to US$780mnApproximately 8% QoQ growth, with gross-margin guidance of 16% to 18%.
• Earnings forecast revisionsSMIC 2026/2027 EPS forecasts raised by 39%/37%; Hua Hong raised by 16%/9%Primarily reflects expectations for better pricing, utilization, and profitability.
• Target pricesSMIC HK$100; Hua Hong HK$175Buy ratings maintained on both.

Impact & implications

If tight mature-node supply-demand conditions, higher ASPs, and high utilization persist, SMIC's and Hua Hong's profitability and valuation levels may continue to improve. For the industry, beneficiaries of the AI capital-expenditure cycle are expanding from advanced nodes to mature-node supply chains including power management, MCUs, flash memory, power devices, and specialty processes.

Risks

• Mature-node end demand or China semiconductor demand may fall short of expectations.
• Industry capacity additions may exceed expectations, weakening supply-demand tightness and pricing power.
• Falling ASPs or intensifying price competition may compress gross margins.
• SMIC's advanced-node ramp-up, depreciation burden, and R&D investment may erode profit margins.
• Global macroeconomic weakness may suppress semiconductor end demand.
• Changes in the pace of localization and policy support may affect order and earnings expectations.

What to watch

• Whether SMIC's and Hua Hong's 3Q26 revenue, gross margins, and capacity utilization meet or exceed guidance.
• Implementation of price increases, ASP trends, and delivery lead times for mature-node products, particularly 8-inch, PMIC, BCD, MCU, flash, and power devices.
• Progress in SMIC's new-capacity qualification and the sustainability of utilization rates.
• Tool installation and mass-production progress at Hua Hong's Wuxi Fab 9A, as well as the ramp-up pace of Fab 9B in 2027.
• The impact of China localization demand, AI hardware capital expenditure, and global 8-inch capacity exits on the supply-demand landscape.