UMC - GlobalFoundries: The Argument For And Against

Summary

• GFS is off to a good start and there are a number of arguments to be made as to why it could stay that way in 2023.
• There are a number of reasons why some may decide to stay away from GFS, even though it has a number of things in its favor.
• There is a case to be made in favor of long GFS, just as there is a case against it, which suggests staying neutral is the way to go.

GlobalFoundries ( GFS ), a provider of foundry services to the semiconductor industry, is off to a good start in 2023. The stock has gained almost 10%, continuing the uptrend that started in mid-2022. The rally has been aided by several factors, including a good earnings report along with guidance that was much better than expected. However, while there are solid arguments in favor of long GFS, there may still be reasons why some may want to take a pass on GFS. Why will be covered next.

The uptrend continues

The year 2023 is off to a good start for GFS with the stock gaining almost 10% YTD in a couple of weeks. The rally has reversed some of the losses that GFS suffered in the closing weeks of 2022. It also kept intact the uptrend that started in the middle of 2022, which helped narrow the stock’s losses in 2022 to 17%. GFS thus outperformed most semiconductor stocks. The iShares PHLX Semiconductor ETF ( SOXX ), for instance, lost 36% in 2022.

The chart above shows how the stock has trended higher in recent months. Note the higher lows and the higher highs starting from July of last year. The trend is pointing up, which is an encouraging sign for anyone who is thinking of going long GFS. In addition, it’s worth mentioning that the stock is about 1.5% away from overtaking the 50-day moving average, which would also be seen as a bullish signal.

What factors support higher prices for GFS

The rally higher has been supported by a number of tailwinds. For starters, the entire semiconductor sector has rallied thanks to the perception that several of the headwinds that caused problems for the sector are starting to recede. Semiconductor demand has weakened, but TSMC ( TSM ), the world’s leading foundry, is forecasting a rebound in semiconductor demand in the second half of 2023 in its latest outlook .

Furthermore, there is the growing belief that the Federal Reserve will ease up on its tightening of monetary policy, something that has weighed heavily on stocks, semis included. GFS has benefited from this as can be seen in how the stock jumped higher on November 10 when inflation came in better than expected, which supports the case for a Fed pivot.

GFS has also done its part. The company’s guidance calls for Q4 revenue of $2.05-$2.10B and adjusted EPS of $1.24-1.44, which far exceeded expectations of $1. Keep in mind that the EPS number includes a one-time gain due to the sale of a fab, which boosted EPS by $0.63-0.72. The better-than-expected guidance for Q4 came on top of GFS surpassing consensus estimates of $0.62 for EPS and revenue of $2.05B with actual revenue of $2.1B and EPS of $0.67 in the preceding quarter.

Guidance did not extend beyond Q4 and GFS acknowledges the semiconductor market is facing challenges, but GFS still expects FY2023 to be a growth year, if only by a modest amount. From the Q3 earnings call:

“One is our underutilization is predominantly and I mean predominantly our 200-millimeter, not our 300-millimeter facilities. And even with all of that, we still expect 2023 to be a modest up year for us.”

A transcript of the Q3 FY2022 earnings call can be found here .

Finally, GFS has one last ace up its sleeve. GFS is a foundry with its headquarters in the U.S., which, unlike other foundries like TSM and United Microelectronics ( UMC ), does not have most of its manufacturing presence in Taiwan, which means it is perceived to be less exposed to tensions across the Taiwan strait.

GFS is seen as a potential winner from efforts to bring back semiconductor manufacturing to the U.S., which is currently mostly located in East Asia. GFS could benefit from U.S. government initiatives like the U.S. Chips Act. GFS has, for instance, recently received federal funding to advance production of next-generation chips in the U.S. The top foundries are all from East Asia with the exception of GFS and GFS could be a beneficiary due to this.

Why some may hesitate to back long GFS

There are a number of arguments to be made in favor of long GFS, but there are still reasons why some may decide to refrain from jumping in. GFS currently holds the number four spot in the foundry market, behind TSM, Samsung and UMC, but ahead of SMIC. However, GFS looks expensive in several metrics compared to its peers.

Keep in mind that GFS could be ranked third since Samsung is not a pure-play foundry like the other four. GFS is most comparable to UMC with TSM the benchmark as the dominant foundry. The table below shows some of the multiples for these three companies. In general, anyone who wants to get in on GFS will have to pay a premium to do so.

Source: SeekingAlpha

Multiples for GFS are significantly higher than the other two, even though it is smaller, has not grown as fast and is less profitable with lower margins. The balance sheet is also worse off compared to the other two. GFS also does not pay out a dividend, unlike TSM and UMC in particular, which could be a difference maker for some.

There are clouds hanging over the foundry market

There is another reason why some may be hesitant to jump in. While GFS may be optimistic about its prospects in 2023, there’s no denying that the foundry market and the semiconductor market are currently facing declining demand. For instance, the semiconductor market is forecast to contract by 4.1% in 2023 according to WSTS. TSM, for its part, predicts the foundry market will shrink by about 3% in 2023 after growing by 27% in 2022, an H2 rebound notwithstanding.

Most forecasts assume conditions will start to improve in H2, in line with what TSM is saying, but these forecasts could turn out to be too optimistic. The forecasts may have to be revised in the coming months, just as previous forecasts in recent months have been lowered as the market for semiconductors deteriorated. There is a lot of uncertainty out there as it pertains to semiconductor demand, which means it is unwise to bet heavily, especially if it is based on current forecasts.

It’s also worth mentioning that GFS is counting on the automotive market to continue to outperform. GFS intends to raise prices again, which was easy to do when the chip market was hot, but could become harder to do if or when utilization at foundries goes down due to slumping demand. Basically, the outlook is hazy, which argues in favor of taking a cautious approach.

Investor takeaways

I am neutral on GFS. There are certainly a number of arguments in favor of long GFS. The top and the bottom line continues to grow. While demand has weakened in the foundry market, GFS expects to outperform the market. The fact that it is the only top five foundry not from East Asia could make GFS the beneficiary from ongoing efforts within certain segments of the semiconductor industry to lower their exposure to East Asia.

Semis seem to have regained favor in 2023 after a very difficult 2022, although it is still early in the year. The year 2022 was not a bad year as many semiconductor companies, GFS included, posted strong gains in sales and profits, but their stocks still suffered big losses as they had to contend with various headwinds, including inflation and monetary tightening by the Federal Reserve in particular.

At the moment, it looks as if these headwinds are becoming less potent and will be less of a problem in the new year. Many investors are anticipating a change in Fed policy, at least in comparison to 2022, and are positioning themselves accordingly. Semis lost more than most in 2022 due to Fed policy, which means the reverse could also be true. Semis could win more than most in 2023 if Fed policy changes from what it was in 2022. GFS could hitch a ride on the back of semis regaining favor.

The charts are also suggesting higher stock prices are in the pipeline for GFS. The stock is currently in the midst of an uptrend that has been in place since the middle of 2022. There is a saying that the trend is your friend and in the case of GFS the trend is clear. Long GFS looks very tempting with all these factors in its corner.

However, there is also no denying that GFS trades at higher valuations than its nearest competitors. Some might argue paying a premium is justified as GFS is, for instance, less vulnerable to geopolitical tensions compared to UMC and TSM, but not everyone is likely to agree. Some might conclude multiples for GFS are too high when there are better alternatives out there.

It’s also worth mentioning that GFS does not have that great a track record when it comes to growth since it was spun off. One could argue that GFS has the worst track record among the top five foundries. GFS has done better recently, but its past history may be enough to put doubt in the minds of some people as to whether putting money in GFS is a wise move.

People may also be wary of investing in foundries at a time when the foundry market looks to be heading down. It’s true that many, including the leading foundry, are expecting a recovery starting in H2 2023, but this is not a sure thing. Companies could easily be forced to lower their outlook once again, as they have been doing in recent months.

Bottom line, there is a case to be made in favor of long GFS, but there is also a case to be made against it. Ultimately, it comes to down to which arguments look to be the more persuasive ones, which may be different depending on the individual. Either side could be right or wrong, which suggests it may be better to keep your options open by not taking any sides, at least at this point in time.

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