United Microelectronics Corporation Stock: The Foundry Market Is Changing (NYSE:UMC)

It used to be that United Microelectronics Corporation or UMC (NYSE:UMC) and GlobalFoundries (GFS), both providers of foundry services to the semiconductor industry, used to jockey as to who was the second-biggest foundry after Taiwan Semiconductor Manufacturing Company or TSMC (TSM), if we exclude companies like Intel (INTC), or Intel Foundry Services to be exact, and Samsung (OTCPK:SSNLF) that are not pure-play foundries. However, that changed in Q1 2024 when neither managed to rank number two after all had reported their quarterly results. Instead, the number two position went to SMIC, otherwise known as Semiconductor Manufacturing International Corporation (OTCQX:SIUIF), for the first time. Furthermore, SMIC is likely to hold on to this position. Some might see this as having negative repercussions for UMC, but the ultimate impact is likely to be more nuanced. Why will be covered next.

Why shareholders got a pleasant surprise from UMC

A previous article from last February took note of the slack in capacity utilization, which put pressure on the top and the bottom line at UMC. Still, the article noted there was enough reason to hold on to UMC and rated it accordingly. The article, for instance, estimated UMC was likely to spend about half of FY2023 EPS of NTD4.93, or NTD24.65 or $0.80 per ADS, on dividends based on what happened in previous years.

This implied a dividend of about NTD12.33 or $0.40 per ADS. However, UMC’s Board of Directors upped its dividend payout this time around by setting the dividend for this year at NTD3.00 a share, or almost 61% of NTD4.93, which translates to NTD15.00 or $0.47 per ADS, using an USD:NTD exchange rate of 1:31.99. This converts to a dividend yield of 5.4% with the stock at $8.67 per ADS as of May 30, which compares very well to most stocks, especially tech stocks.

Resistance is close to UMC

The stock is up 2.5% YTD and that is with a rally in recent weeks as shown in the chart below. In fact, the stock set a new 2024 high of $8.89 as recently as May 28, only to fall back in the last few days. Furthermore, the chart shows something worth noting. It is not the first time the stock has struggled once it got close to $9 or so.

The stock similarly retreated in June 2023 with a high of $8.97 and in March 2023 with a high of $8.96. The stock managed to briefly peek above $9 in June 2022 with a high of $9.10, but this too ended quickly with the stock turning south. All these occurrences are unlikely to be a coincidence. The stock has not been able to get past $9 or so for the last two years for a reason and the most likely cause is because resistance is close by.

How SMIC was able to overtake UMC and GFS

There was other news recently besides the dividend authorization by UMC. UMC saw the rankings of the top pure-play foundries change once all the Q1 results from the various players were tabulated. UMC is still in the top five, but TSM is by far the biggest foundry around. A recent report, for instance, credited TSM with a 60% share of the foundry market worth $117B in 2023.

Trailing much further behind were Samsung, GFS, UMC and SMIC, the top five. However, Samsung services mostly internal demand, similar to Intel Foundry Services, which is only getting started. Also, unlike the other three in the top five, TSM focuses mostly on the leading edge, defined as process nodes of 7nm or smaller.

GFS, UMC and SMIC are more closer to each other. Not only are they more similar in size compared to TSM, but all three derive most, if not all, of their revenue from process nodes of 28nm or larger. Historically, UMC and GFS were bigger than SMIC, but this changed in Q1 2024 when SMIC reported quarterly sales ahead of UMC and GFS for the first time, as shown in the table below.

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Source: UMC, GFS and SMIC

SMIC was able to do this because it has been investing far more than its two closest peers in both technology and manufacturing capacity, which paved the way for SMIC to overtake its closest peers in the foundry space. The table below, for instance, shows how capex spending at SMIC far exceeds that of UMC and GFS in absolute terms, but especially as a percentage of revenue.

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Most of the capex is directed towards building new manufacturing capacity. This suggests SMIC is likely to retain the number two spot among pure-play foundries for the foreseeable future because the new capacity can be expected to bring in additional revenue. Quarterly guidance also suggests SMIC will retain its position.

SMIC’s Q2 2024 guidance of an QoQ revenue increase of 5-7% is better than that of UMC or GFS. On the other hand, while SMIC can expect to see the top line grow, the bottom line will have to wait. This is because heavy capex spending will cause depreciation expense to soar higher, which will lower the bottom line in the next several years. Note that depreciation expense is also set to go up at UMC in 2024.

What should UMC shareholders make of the recent changes in the foundry market?

One question that may arise if you are a UMC shareholder is what impact, if any, there will be on UMC. Some people may argue that SMIC taking over of the number two spot, and UMC falling to number three or even four, is concerning for UMC since it suggests SMIC is outperforming UMC, even if it comes at a price.

Keep in mind UMC has singled out the massive expansion of production capacity in China as a factor that may affect revenue and profits at UMC. This is why UMC thought it important enough to have it included in the latest annual report as a potential risk factor. From the annual report:

“China has been developing semiconductor supply chain autonomy. Due to restrictions on the import of advanced technologies and equipment, China turns to massive expansion of mature node production capacity and actively subsidizes domestic manufacturers. Semiconductor manufacturing competitors in China have been able to reduce price to expand their market share with the support of government subsidies. It is estimated that as China semiconductor capacity continues to grow, the competitive situation will be more exacerbated. This may have an impact on UMC’s orders, revenue and profits”

This concern is given greater impetus after taking a look at recent quarterly results at UMC. The top and the bottom line have come under pressure. The main cause is the state of the semiconductor market, but it is easy to see why some might believe that SMIC is contributing to the results, especially in light of what UMC has stated in the latest annual report. For instance, Q1 revenue was basically flat at NTD54,632M, which converts to $1,708M using a USD:NTD exchange rate of 1:31.99. EPS declined by 35.9% YoY to NTD0.84, which translates to NTD4.20 or $0.13, $0.131 to be more exact, per ADS.

Wafer shipments increased by 4.5% QoQ to 810K and the quarterly capacity was 1,212K, both in 12-inch equivalent. The utilization rate was 65% in Q1 FY2024, down from 66% in Q4 FY2023 and 70% in Q1 FY2023, UMC finished with cash and cash equivalents totaling NTD119.43B or $3.73B, partially offset by long-term credit/bonds worth NTD43.45B or $1.36B. The table below shows the numbers for Q1 FY2024.

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Source: UMC report

FY2024 will get better for UMC

Guidance calls for Q2 FY2024 to be similar to Q1 except for an increase in wafer shipments in the low single digits. Using the below guidelines, UMC is estimated to earn $0.14-0.15 per ADS on revenue of $1.75B in Q2, although exchange rate fluctuations could sway the final number. From the Q1 earnings call:

“Now, let’s move on to the second quarter 2024 guidance. Our wafer shipments will increase by low single-digit percentage. ASP in US dollars will remain firm. Growth margins will be approximately 30%. Capacity utilization rate will be in the mid 60% range.”

Source: UMC earnings call

The above is in line with the FY2024 outlook provided by UMC at the start of the year, but also with seasonal trends. The FY2024 outlook calls for UMC to grow in line with the foundry industry, which is seen to grow in the high single digits by UMC. This suggests FY2024 revenue of $7.9B if UMC grows by 9% YoY, which would result in EPADS of around $0.75, after taking into account higher depreciation expense and depending on the exchange rate. This implies a P/E ratio of 11.6x with the ADS at $8.67.

Why the impact on UMC by SMIC is likely to be more nuanced

Some might try to connect the dots and conclude that the rapid expansion by SMIC is a headwind for UMC. Given current conditions it is understandable if some people are apprehensive about seeing SMIC spend so heavily on added production capacity when UMC itself already has more capacity than it can utilize.

An argument can be made that if SMIC wants to keep all its newly added capacity loaded to keep growing at a rapid pace, SMIC will have to snatch some customers that are currently using the services of other foundries, including UMC. This could develop into a headwind for UMC, which UMC can do without since UMC is already dealing with a slack in fab utilization.

However, the impact on UMC is likely to be more nuanced. China is trying to reduce its need for semiconductors manufactured elsewhere and the building up of SMIC is part of that equation. UMC though has its own fab in China, unlike GFS, which can be used to service Chinese clients. China is trying to replace foreign semiconductors, particularly those from the U.S. with its own, but not all chips are manufactured by foundries like UMC.

Not everyone uses foundries. If the replaced chips were made by IDMs, than there is no change for a foundry like UMC since the IDM did the manufacturing. For example, China has decided to block the use of CPUs from the likes of INTC in government computers, but since those are made by INTC, nothing has changed for UMC. There are many other examples.

Many non-Chinese companies cannot easily switch to SMIC for various reasons, which includes U.S. government regulations. U.S. companies in particular have to stick with foundries outside of China for the most part, which includes UMC, but not SMIC. A large number of UMC clients are sole source and switching to a different foundry presents various technical challenges, even if it was an option for a company.

This includes the potential need for a complete chip redesign due to incompatible design rules, which companies want to avoid due to the time and cost associated with going that route. So it is quite a stretch to say that whatever SMIC gains must come out of the pocket of UMC. It is not a 1:1 relation. Some companies may be adversely impacted, but UMC does not have to be included. SMIC is likely to become a much bigger foundry in the coming years, but that does not mean UMC cannot carve its own niche in the foundry market and also do well.

Investor takeaways

UMC has shown why it quite literally pays to stick with UMC. Shareholders can expect a NTD3.00 dividend in July, which translates to a yield of 5.4%. While the latest quarterly results show flattish revenue growth in Q1 FY2024, they are expected to get better as the year goes by. UMC is currently investing in various projects for new capacity, which will affect the bottom line in the short term, but this will allow for future growth.

UMC ranked third among pure-play foundries and that ranking is likely the best it can hope to achieve for the foreseeable future. That is because SMIC and TSM are out of reach for various reasons. While some may argue SMIC presents a headwind for UMC, the impact is not likely to be as bad as some might think it is. Obviously, only one company can rank number two, but that does not automatically mean SMIC is bad for UMC. There are other factors to take into account.

SMIC going up does not necessarily mean UMC has to go down. It is perfectly possible for UMC to prosper even if SMIC builds out all the new capacity scheduled to come online in the coming years. It is a stretch to say that UMC must suffer for SMIC to rise. Both can do well in their own way at the same time. While there is some overlap, there are also many areas in the market where they can coexist without any issues.

This is not to say that all the building of new fabs by SMIC or who else is irrelevant. If, for example, semiconductor demand were to collapse worldwide due to, for instance, a global crisis like the one in 2008/2009, then having a lot of fab capacity around could make it harder for the industry to get back on its own two feet. SMIC could affect UMC in the years ahead, but it is premature to say it has to be in a negative way, which is how some people look at it.

Nonetheless, it is worth mentioning that the stock is currently close to what can only be resistance if the charts are any indication. So while I continue to hold on to UMC, I would not put new money to work by being a buyer with resistance close by. The nice thing about UMC is that the stock does not necessarily have to rise for shareholders to come out ahead due to the generous dividend, unlike other stocks. That is something worth having.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.