Hua Hong’s 2Q24 results were mixed with revenue and NI both missing due to weak ASP but GPM beat high-end guidance driven by UTR which improved sequentially to around 100%. We believe Hua Hong will continue its gradual recovery in 2H24 as consumer electronics enter peak season and a high UTR should support ASP. The ramp-up of Wuxi fab9 in early 2025 will be a new challenge but with the experience of fab7, we expect the learning curve should improve significantly. Hua Hong remains undervalued in our view with the long-term trend of domestic substitution. We rate Hua Hong BUY with HK$23.8 TP, based on 0.80x P/B.
　　Key Factors for Rating
　　2Q24 financials mixed: Revenue decreased by 24% YoY but increased 4% QoQ to US$479m, at the midpoint of guidance. GPM increased 4ppts QoQ to 10.5%, exceeding the high end of guidance, driven by UTR improvement from gradual consumer electronics demand recovery. NI was US$7m, missing BOCIe and consensus due to FX loss and heavy G&A cost for new fab operations.
　　Positive 2024 guidance maintained: although 3Q24 GPM guidance of 10- 12% slightly missed consensus of 12%, mgmt. explicitly mentioned there is upside potential if price adjustment is done smoothly, given a moderate demand recovery across consumer electronics, auto and IoT in 2H24. Mgmt. targets to raise ASP by 5-10% by end of 2024.
　　Wuxi fab9 will start risk production in late 2024: Wuxi Fab9 is scheduled to enter risk production in 4Q24 and commence volume production from 1Q25. Initial capacity ramp target is 20kWpm by end of 2025, at a slower pace than we thought. So we think UTR and ASP pressure will be smaller in 2025. With new capacity coming through nationwide while macro remains uncertain, we expect Hua Hon’s recovery will be mild and gradual as market needs time consuming all the new capacity. The learning curve of Wuxi fab7 took more than five years.
　　Valuation remains attractive: While demand visibility remains low and Hua Hong has relatively less GenAI revenue exposure, its current 0.67x P/B (including cash) provides enough downside protection. We remain positive on consumer electronics demand recovery and semi domestic substitution.
　　Key Risks for Rating
　　US-Sino relationship; mature node price competition; faster-than-expected product migration to advanced node; macro and end demand risk.
　　Valuation
　　We derive our new HK$23.8 target price based on 0.80x P/B, -0.5sd below its five year average multiple of 1.4x. Our target price represents 32x/18x/14x 2024E/25E/26E EPS.