Hua Hong reported a mixed 2Q25 results with in-line revenue but strong GPM of 10.9% (+1.6ppts QoQ), driven by wafer shipment (+6% QoQ) and UTR (+5.6ppts QoQ) beats, though partially offset by depreciation charges. Mgmt. guided strong 3Q25’s revenue of US$620- 640m (+11% QoQ mid-point, 5% above consensus) with stable GPM, given price increase impact and demand growth across most sub- segments. The current debates around Nvidia’s chip backdoor should benefit domestic foundries including Hua Hong while we see solid demand from AI server to digest new capacities. The potential consolidation of HLMC continues to act as a key catalyst. We maintain BUY with new target price of HK$51.1 based on 1.8x P/B.
　　Key Factors for Rating
　　2Q25 results mixed: Revenue grew 18% YoY and 5% QoQ, slightly above guidance mid-point, mainly thanks to increase in wafer shipments (+6% QoQ, though partial driven by pre-order for mitigating tariff risks). GPM improved 1.7ppts QoQ to 10.9%, beating high end guidance of 9%, mainly thanks to the UTR improvement but partially dragged by D&A of Fab9. NI recorded US$8m, missing consensus and BOCIe by 77% and 38%, mainly due to increased engineering wafer costs, new fab start-up-cost and FX loss. Analog and PMIC remained key outperforming segments in 2Q25 thanks to booming AI server demand from both domestic and overseas customers.
　　Decent 3Q25 guidance driven by sustained growth from most sub- segments and improving ASP: Mgmt. guide 3Q25 revenue to reach US$620- 640m (+11% QoQ mid-point, 5% above consensus) with GPM to be 10%-12% (+0.6ppt QoQ mid-point, +2.3ppts above consensus), given the 1) price adjustment in 2Q25, 2) strong analog and PMIC demand for AI server, 3) consistent local demand, and 4) sustained consumer electronics demand. However, Company targets to ramp Fab9 at a faster pace than we expected, reaching 80-90% designed capacity by end of 2025, and we believe growth in depreciation charges will likely cap GPM upside in near to mid-term.
　　Domestic substitution trade likely to sustain: Although tariff war shows signs of easing, uncertainties persist. The market focus has soon turned from the lift of H20 ban into a debate of whether Nvidia has or should have a backdoor/tracker in chips. We believe such a negative shift in sentiment will favour Hua Hong, as the narratives in both domestic and the US will again move towards domestic substitution. The plan of HLMC (advanced node) injection by August 2026 should also be a key near term catalyst for Hua Hong.
　　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 slightly increase revenue and GPM estimate considering a packed capacity and faster-than-expected new capacity add, but price war, engineering cost and growing depreciation charge have capped near-term margin upside. As a result, we cut 2025E EPS by 34% but increase 2026/27E EPS by 18%/39%.
　　We derive our new HK$51.1 target price based on 1.8x P/B (was 1.5x) as we believe the chip war and upcoming HLMC injection will lead to a re-rate of Hua Hong as the second largest foundry with advanced node in China. Our target price represents 149x/54x/37x 2025/26/27E EPS.