Why To Add Semiconductor Manufacturing International To Your Stock Portfolio

While semiconductor stocks may not be as glamorous among investors as Apple or Google, they still make solid additions to any stock portfolio, particularly given the increasing popularity of mobile devices such as smartphones and tablets, which boosts demand for chips to power them. The pursuit of lower manufacturing costs has increasingly shifted production of semiconductors to Asia, where a large number of the world's biggest chip manufacturers are now based.

Semiconductor Manufacturing International (NYSE: SMI) is a Shanghai-based semiconductor firm that is the world's foremost independent foundry for the logic chips used in mobile devices. Its major customers include Texas Instruments, Qualcomm and Broadcom. Some analysts have identified SMI as a stock pick due to its dominant market position as well as expectations for future growth of the semiconductor industry. Should you add this stock to your portfolio?

SMI Fundamentals

In its first quarter 2013 earnings report, SMI reported that it recorded its fourth successive quarter of all-time high revenues at $501.6 million, a more than 50% increase from the $332.7 million in the same quarter in 2012. The increase was attributed to continuing strong demand from the foundry's China-based customers, accounted for some 38.6% of total revenue compared with 32.5% from a year ago. The bulk of revenues, however, continued to come from North American customers, who made up 51.4% of overall revenues, a slight decline compared with the 55.2% reported in the same quarter last year. Income attributable to SMIC was reported at $40.6 million from a net loss of $42.8 million in the same quarter last year. However, this was a slight decline from the $46.6 reported in the fourth quarter of 2012.

Gross margin, or the percentage of revenue that the company keeps as gross profit, also continued to rise. For the quarter under review, gross margins reached 20.4% from 12% in the same period last year. Meanwhile, SMI's capacity utilization for the quarter was at 89%, indicating that it was close to using its full capacity. Although this was a slight decline from the 90.5% reported in the fourth quarter of 2012, it was a substantial increase over the 74% in the first quarter of 2012. For the quarter, 631,776 wafers were shipped, compared with 445,689 in the same quarter last year.

The company's outlook for the second quarter remained optimistic based on its guidance. It expected to see revenue increase 3% to 5% on a quarter-by-quarter basis, while gross margins would remain within the 20% to 22% range. Meanwhile, expenses from its continuing operations were expected to fall within the $85 million to $88 million range (excluding the effects of government research grants and forex fluctuations).

Industry Outlook

The future of SMI, however, is dependent on the strength of the industry, since this fuels demand for the company's products. According to projections by the World Semiconductor Trade Statistics, the global market for semiconductors is expected to grow by 4.5% this year after falling by 3.2% in 2012. The industry actually recorded total sales of $291.6 billion last year, the third highest ever, but this was coming from the record-high $299.5 billion recorded in 2011.

Meanwhile, in China, the semiconductor market is expected to increase by 12% in 2013, mainly due to the country's role as a manufacturing hub for tablets and smartphones. Some 672 million smartphones and 187 million tablet computers are expected to be produced in China in 2013, with this number expected to grow to 1.3 billion and 407 million, respectively, by 2017.

This creates a great opportunity for SMI, which has decided to focus its manufacturing on areas of application unique to the Chinese semiconductor industry. For example, one area it is focusing on is embed novel technology, which equips hardware with software designed to meet its specific purpose. In the Chinese context, for instance, embed technology is expected to be used extensively in smartcards such as credit cards and cards used to avail of services like healthcare and social security.

SMI is also the second-biggest CMOS image sensor foundry in the world and recently announced that it had achieved a breakthrough in developing backside illuminated ((NYSE:BSI)) CIS technology, which allows for good image quality to be produced even in low light conditions. With this technology, the company hopes to offer customers smartphone cameras and video cameras with resolutions of five megapixels and higher.

The Bottom Line

While Semiconductor Manufacturing International may not be a household name, it does not mean that it would not make a valuable addition to your portfolio. While its current share price of $4.46 seems low, it is actually selling at nearly 140% higher than its price the previous year. A technical analysis of its share prices shows that the trend is upward in the long, short and medium term. And with the growing importance of China as a semiconductor hub, there is no reason why SMI will not continue to be profitable in the years to come.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.