The semiconductor industry is currently experiencing a gentle cyclical recovery, particularly as the inventory surplus faced by downstream customers is finally beginning to declineRecent trends reveal that demand from consumer electronics, electric vehicles, and artificial intelligence (AI) applications are driving the growth for domestic wafer foundries in ChinaThis resurgence is further fueled by the shift towards localized production strategies among both customers and supply chains, marking a noteworthy change in the industry's dynamics.

Amidst this recovery, domestic foundries are simultaneously grappling with pressures on depreciation and pricing in mature processes, complicated by the need for expansion amid soaring demandThe notion of “local for local” has become a significant theme; a leading engineer from a major wafer foundry in Shenzhen remarked on the overwhelming influx of domestic orders, illustrating a remarkable increase in capacity utilization since the third quarter of last yearEven during the recent Chinese New Year holiday, many employees were working at three times their normal capacity.

Semiconductor Manufacturing International Corporation (SMIC), the largest foundry in mainland China, is on track to surpass GlobalFoundries and UMC in 2024, positioning itself as the second largest worldwide, just behind TSMCDuring a recent earnings call, CEO DrZhao Haijun elaborated on the projected recovery in the semiconductor market, emphasizing that inventory levels among design firms have returned to healthy levels and that a rapid transition towards domestic supply chains has been underway.

In 2024, SMIC is expected to see its revenues climb throughout all four quarters, outperforming initial expectations, primarily due to swift validation and ramp-up of new products from domestic clients last year.

The traditional model of globalized production in the semiconductor sector is being increasingly challenged by the intensifying focus on local production

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Factors such as geopolitical risks and supply chain security have triggered a distinct shift in how wafer foundry clients operate, with local production becoming a hallmark of this industry recovery.

An examination of SMIC's revenue sources reveals a 34% year-over-year increase in sales within China, accounting for a staggering 85% of its total revenue, which represents a historic highsRecent financial reports indicate SMIC achieved continuous revenue growth over seven consecutive quarters, exceeding $2.2 billion in the fourth quarter of 2024, and realizing shipments surpassing 8 million wafers for the year, with an average capacity utilization rate of 85.6%.

In tandem, another local foundry behemoth, Hua Hong Semiconductor, recorded fourth-quarter sales reaching $539 million, reflecting a 2.4% sequential increaseThe company's capacity utilization rate surged, peaking at 103.2% by the end of the last quarter, while sales revenue from the domestic market surged by 23% year-over-year to account for 83.7% of total income.

In addition to seizing localized orders, Hua Hong is also partnering with European firms to bolster its supply chain collaborationLast November, STMicroelectronics announced their cooperation with Hua Hong to advance 40nm microcontroller unit (MCU) manufacturing, utilizing identical equipment and technology as employed at ST factories to ensure consistent product qualitySimilarly, companies like Infineon and NXP are planning to produce chips at Chinese wafer factories.

Company executives have touched upon the significance of collaborating with key international clients as part of their strategic goalsHua Hong's partnership with STMicroelectronics in the MCU sector is particularly noted as an integral aspect of future business, with additional negotiations with other manufacturers expected to yield results shortly.

European companies are actively pushing for a “China for China” strategy, with Hua Hong being recognized for its strong reputation in localized technologies and mature process domains, contributing to its appeal among these partners

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The broader industry landscape is shifting due to the drive towards localized operations, reshaping traditional supply chains and market dynamics.

Industry experts like TrendForce's Senior Research Vice President Guo Zuorong highlight that due to geopolitical competition, some companies are relocating capacity from domestic markets to overseas, while local firms are gradually shifting their foreign capacities back to ChinaThis trend appears to be irreversibleFor instance, World Advanced's establishment of a new 12-inch manufacturing plant in Singapore has attracted significant orders, while TSMC's operations in Arizona are expected to bolster the U.S.’s share of advanced process capacity from 9% to 21% by 2025, with Japan aiming for a 4% capacity share by then.

As demand continues to surge, particularly driven by the AI sector, the recovery in the terminal markets is gaining momentumHowever, despite the optimism surrounding localized orders, experts express caution regarding their sustainability in boosting performance significantlyZhao Haijun predicts a slower transition towards “local for local” substitutions, projecting a market environment where growth does not inherently drive up pricesForecasts for 2025 suggest that while AI will maintain rapid growth, demand across different application areas will remain flat or see only mild increases.

Following the downturn in 2023, the industry is currently observing low inventory levelsWith stock replenishment needs and nascent demands, the prognosis for wafer foundry demand looks favorableAlthough AI core chips are predominantly associated with advanced processes, opportunities within mature process technologies also aboundFor example, Hua Hong's recent excitement over domestic AI models like DeepSeek encapsulates this sentiment, as they anticipate that rapid advancements in AI will invigorate the semiconductor market holistically.

Emerging applications in the AI sector necessitate not only advanced chips but also support chips for foundational hardware architecture

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Although Hua Hong may not directly engage in the manufacture of advanced AI chips, the company recognizes strong demand in peripheral products tied to AI contexts, such as data centers and power management systemsAs a result, they expect to see indirect benefits from the AI industry's growth.

Moreover, companies focused on specialty process wafer foundries, such as Chipone Integrated Circuits, are positioning themselves in the burgeoning smart computing centers associated with AI technologyThe current window represents a golden opportunity for these sectors, with plans to focus on power supplies and related products tailored for AI server applications, reflecting a commitment to stay attuned to market trends in the AI domain.

Clearly, the automotive and electric vehicle sectors are also playing a crucial role in hastening the recovery within the wafer foundry domainExecutives from Hua Hong recognize that inventory adjustments across these terminal markets are largely complete, fostering a cautiously optimistic environment as normal demand levels are anticipated to returnThe company is committed to developing new power device products and MCUs through enhanced research and development efforts, assuring that they stay advantageous within the evolving market landscape.

In the fourth quarter, automotive and industrial segments accounted for 8% of SMIC's revenues, with aspirations to scale this up to 10% in the foreseeable futureThe company has achieved automotive-grade certifications across various platforms—high-voltage, high-current, and analog products—positioning itself advantageously for mass production and applications in the automotive sector.

Nevertheless, the timeline for expanding revenues from automotive products is constrained by the lower volume of car sales relative to mobile devices, as well as the extended certification processes required for automotive-grade products, as Zhao Haijun elaboratedHe indicated that rigorous evaluations must be completed before gradually ramping up production.

Historically, the pandemic has catalyzed rapid expansions among domestic wafer foundry players, leading to what many are now calling the “capacity flood.” Industry predictions from TrendForce suggest a substantial augmentation of production capacities by 2025, specifically pointing towards a potential 25% share of mature process capacities among the top ten players in mainland China.

Moreover, according to the Semiconductor Equipment and Materials International (SEMI) report, global manufacturing capacity is expected to rise from 6% in 2024 to 7% in 2025, reaching an unprecedented monthly capacity benchmark of 33.7 million wafers

In China alone, 18 new wafer foundries are projected to launch, raising their output from 7.6 million wafers to 8.6 million wafers monthly.

While increasing capacity enhances competitive edge, it simultaneously introduces depreciation and pricing pressuresIn the latter half of last year, concerns arose regarding a potential 40% price cut at SMIC, although fourth-quarter averages did show a sequential price increase of 6%. This uptick has been attributed to more expensive 12-inch wafer shipments and customizable products that effectively mitigated depreciation and competitive market pressures.

“We will not actively reduce prices,” Zhao remarked, indicating the company’s intent to maintain market share and competitive advantages across various sectors, while anticipating some pricing volatility in the early part of the upcoming yearThe company intends to focus on optimizing production efficiency and product diversity to buffer against cyclical downturns.

Hua Hong is poised to encounter similar depreciation challenges, particularly with the recent launch of its $6.7 billion wafer fabrication facilityThis new plant is projected to reach a monthly capacity of 40,000 wafers by mid-2025, fundamentally augmenting depreciation expenses as it becomes operational.

In their outlook for the industry, Hua Hong executives expressed confidence that 2024 prices may have reached their nadir, targeting a recovery in margins through strategic product line adjustments to bolster average sales pricesAccordingly, they recognize that the factors influencing product pricing will likely be less substantial than the depreciation impactsThey expect margins on their newly established 8-inch production lines to rebound, even as pressure from the corresponding 12-inch facilities weighs on earnings in the subsequent years.

Overall, industry outlook for 2025 suggests that while mature process pricing will continue to face downward pressure, the evolving landscape driven by localization trends may empower domestic foundries to adopt a more firm pricing stance, potentially mitigating some of the pricing declines

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