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Morgan Stanley RESEARCH IDEA Summary

Key Points

• This report analyzes the impact of reciprocal tariffs on China's semiconductor industry, emphasizing the effects on companies in our coverage with reduced tech product demand. For further details regarding tariff impact, see the section "Evaluating tariff impact."
• Beneficiaries from localization demand include companies involved in semiconductor equipment, leading node foundry, and electronic design automation (EDA), which could outperform due to surging China AI demand. Examples include NAURA Technology, ACM Research, and Empyrean Technology.
• Companies with exposure to key US customers, such as Universal Scientific Industries (USI) and China JCET, are expected to underperform due to the tariff impact. Information on USI's exposure to US customers can be referenced in the same tariff impact analysis.
• We upgraded SMIC to EW (Equal-Weight) rating reflecting strong China local AI/GPU demand and the potential for Chinese customers to use local chips, which could further offset tariff impact on US components.
• China semi equipment and local EDA companies like Empyrean are expected to outperform because localization demand is expected to increase further due to reciprocal tariffs. For detailed stock performance and ratings, refer to the segment impact matrix.

Segment Analysis

Semicon China 2025 Key Takeaways

• AI compute demand is strong but largely driven by domestic cloud providers. Major vendors indicated that AI developers are spending heavily, particularly on small models.
• China is developing suitable GPU chips for AI applications; however, performance still lags Nvidia. For example, the Huawei Ascend 910B is produced at SMIC's N+1 fabrication technology node, but scaling production remains a challenge.
• China's 3D NAND capacity and technology continue to advance, with plans to increase layer counts and expand capacity. YMTC is expected to significantly increase memory capacity and chip density.

Tariff Impact and Safe Harbors

• Reciprocal tariffs are expected to have a negative impact on companies with exposure to US consumer tech. Companies benefiting from localization demand could outperform.
• Companies like SMIC and leading-node foundry could gain market share by reducing dependency on foreign equipment due to tariffs.

Investment Implications

• EMERGING OUTFLOW INCREASE: Semi imports from the Netherlands increased due to barriers on other equipment sources. This is attributed to new restrictions from the US, highlighting the shift toward China's domestic equipment.
• STRONG DEMAND FOR LOCAL CHIPS: Our analysis shows local GPUs or analog chips may become increasingly necessary in industries under increasing trade pressure, with chip demand likely boosting valuation for companies like SG Micro and NAURA Technology.
• PLAYERS TO MONITOR: 37% of Huawei PCs use its own Kirin chips. While using Kirin for AI PCs will increase localization, our outlook remains cautious due to SMIC’s capacity limitations supporting Huawei’s smartphone SoC.

Forward Catalysts

• Upcoming industry events such as Electronica China (April 15–17) and CES Asia (June 8–10) may provide additional insights into progress in China’s localization of semiconductor components.

This report forecasts China's semiconductor self-sufficiency ratio to reach 25% by 2026, led by advancements in equipment, EDA, and analog components, whereas logic and memory capabilities are further hindered by export limitations.