UMC - United Microelectronics: The Outlook Gets More Hazy

2023-05-03 04:35:30 ET

Summary

• The stock did not see it, but UMC had some troubling news to share in its latest earnings call, which might become a problem later on.
• The latest updates from UMC follow those from TSM a week earlier, which means they could indicate a pattern of what’s to come.
• There are still reasons to hold on to UMC, which includes a generous dividend payout in the coming months.
• While many have ignored the warning signs, one should nonetheless pay attention to what is actually happening.

United Microelectronics ( UMC ), one of the leading providers of foundry services to the semiconductor industry, has released its Q1 earnings report. In a number of ways, the Q1 results came in as expected. However, there were also some updates from UMC that were not as expected, including some that UMC could probably do without. Why will be covered next. Read our previous coverage on UMC here.

Q1 results were mostly as expected

UMC managed to surpass expectations in terms of the bottom line, although it also fell short in terms of the top line. Q1 revenue declined by 14.5% YoY to NTD54,209M, which converts to $1,781M using a USD:NTD exchange rate of 1:30.44. EPS declined by 18.6% YoY to NTD1.31, which translates to $0.215 per ADS.

Note that operating income fell even more with a decline of 35.2% YoY to NTD14,481M or $476M. However, the decline in net income was reduced by an increase in non-operating income to NTD4,647M in Q1 FY2023, up from NTD889M in Q4 FY2022 and NTD1,314M in Q1 FY2022. The increase was due to a net investment gain of NTD3,987M and NTD908M of net interest income, partially offset by a loss of NTD239M due to forex.

Margins showed big declines, but that was expected from UMC. The balance sheet finished with cash and cash equivalents of NTD171.83B. Total liabilities amounted to NTD194.08B, resulting in debt-to-equity of 55%. UMC kept its capex budget for FY2023 at $3B. All in all, Q1 came in roughly as expected. The table below shows the numbers for Q1 FY2023.

Source: UMC

Wafer shipments declined by 17.5% QoQ to 1,826K, resulting in a utilization rate of 70%. Furthermore, this is not expected to improve with Q2 guidance basically calling for a repeat of Q1. From the Q1 earnings call:

"Now let's move on to the second quarter 2023 guidance. Our wafer shipment will remain flat. ASP in U.S. dollar will remain flat. Gross profit margin will be in the mid-30% range. Capacity utilization rate will be in the low 70% range."

A transcript of the Q1 FY2023 earnings call can be found here .

UMC lowers its outlook

It's worth mentioning that TSMC ( TSM ), the leader in the foundry market, released its Q1 report less than a week before UMC did. The general expectation, certainly before the recent updates from the likes of TSM and UMC, is that while the semiconductor market is currently in the midst of a downturn, a recovery is to be expected in the second half of 2023.

However, the latest reports have thrown that assumption into doubt. TSM, for instance, had some less than encouraging news to share as it relates to the state of the semiconductor market. While TSM still expects a rebound in chip demand in H2 2023, it also lowered its FY2023 revenue guidance to a decrease in the low to mid single digits due to weaker-than-expected demand, down from an increase in the low single digits. From TSM's Q1 earnings call:

3 months ago, we said we expect fabless semiconductor inventory to start gradually reducing 4Q 2022 and we forecast a sharper reduction throughout the first half of 2023.

However, due to weakening macroeconomic conditions and softening end market demand fabless semiconductor inventory continued to increase in the fourth quarter and exited 2022 at a much higher level than we expected. In addition, the recovery in end market demand from channels reopening is also lower than our expectation."

A transcript of the Q1 FY2023 earnings call from TSM can be found here .

UMC for its part seems to agree with the notion of weaker-than-expected demand. If anything, UMC was even more pessimistic. UMC is yet to see any clear signs of an impending recovery in demand. From UMC's Q1 earnings call:

We are confident for what we have done our company specifically, but for the recovery of the market consensus, we just want to point out that we haven't really seen a very clear signs for a strong recovery as previously, the market was hoping."

UMC thinks the recovery might be much slower to arrive, unlike expectations that call for a relatively quick recovery.

We just see the market actually is going to be much slower than we anticipated, that recovery is going to be much slower than we anticipated."

UMC has therefore decided to lower its FY2023 outlook. The updated outlook calls for the semiconductor market to decline in the mid single digits instead of the low single digits. The foundry market is seen to decline in the high single digits instead of the mid single digits.

And given the weaker than anticipated end market environment, we have seen the pace of the inventory dejection moving slower than expected. So we have not seen any sign of a strong recovery for the second half yet. For the outlook, the 2023, we estimate a semi forecast will further decline from low single digit to a mid-single digit year-over-year for the foundry. And we anticipate it well worse than previous quarter estimate of a mid-single digit. Now we're changing to a decline of high single digit year-over-year."

Earnings estimates have gone down. Consensus estimates now predict EPADS of $0.16 on revenue of $1.78B in Q2 FY2023, way below the $0.29 earned the year before. Estimates project EPADS of $0.66-0.86 on revenue of $7.24-8.11B at the end of FY2023. In comparison, UMC earned $1.15 per ADS on revenue of $9,078M in FY2022.

It was not all bleak news

On a more positive note, UMC has proposed a 2023 dividend of NTD3.60 per share. If approved, this would translate to a dividend of NTD18 or about $0.59 per ADS. In comparison, the 2022 dividend was NTD3 per share, equal to NTD15 or $0.49 per ADS. This implies a dividend yield of 7.4% with a stock price of $8.02. Payout ratio would be 53% with TTM EPS of NTD6.78.

Another plus point for UMC is that it is available at lower valuations than other foundries like TSM or GlobalFoundries ( GFS ), which is arguably its closest competitor. The table below shows some of the multiples for UMC. Note that unlike TSM and UMC, GFS is yet to report. GFS is widely expected to see its top and bottom line decline in its upcoming report, which means the disparity in multiples will become even more pronounced.

Source: Seeking Alpha

The stock maintains the trend

It's worth noting that the stock has shrugged off UMC lowering its FY2023 outlook. The stock actually went up after the latest earnings report, which suggests the market was not too bothered by the worse outlook from UMC. In addition, the existing trend still favors the bulls as show in the chart above. Both the lows and the highs in the stock are pointing higher. The stock gave back a portion of its gains in April, but the stock is still sitting on gains of 22.4% YTD. In comparison, the iShares Semiconductor ETF ( SOXX ) has gained 19.5% YTD.

Investor takeaways

UMC had some welcome news and some less than welcome news. UMC raised its dividend, although there is reason to believe the one that comes next year will most likely not be as generous with earnings in decline. In addition, UMC had previously expressed its belief that the trough in the current downturn will be in H1 2023, if not Q1, and Q2 guidance calling for things to remain flat compared to Q1 is not inconsistent with this prediction.

However, UMC acknowledged seeing weaker-than-expected demand, something that TSM has also stated. As a consequence, UMC lowered its outlook for FY2023. The foundry market is now projected to shrink in the high single digits. UMC also stated it has yet to see any strong signs of a recovery in the near future that the market has been looking for.

Nevertheless, the market seems to have looked past the bad to focus on the good because the stock proceeded to rise in the wake of the latest earnings report. While the stock has shown weakness in recent weeks, the charts continue to suggest staying long is the way to go with the trend pointing up. Still, it would not be prudent to ignore the absence of any signs of a recovery in the industry. Stocks tend to trade based on forward projections, but that does not mean one should ignore what is happening in the rear view since projections are just estimates, which could be wrong and subject to revisions.

Part of the reason why semis have done so well in early 2023 is because of widespread expectations of an impending recovery in the industry, starting in H2 2023. By now there should have been signs of this recovery, but not so as far as UMC is concerned. On the contrary, demand has actually been weaker than anticipated, something that TSM appears to agree with. These updates from TSM and UMC could be a sign of things to come.

Granted, there is time left as H2 is still months away, but it's possible that expectations are too high. The downturn could last longer and a recovery may take longer to get here. If this happens and the market comes to the realization there is no quick recovery heading our way, the stock may have to be repriced accordingly, especially after the rally early this year.

So while I continue to hold UMC, I would also not be a buyer of UMC at this time as stated in a previous article . It's true UMC looks relatively cheap with multiples where they are, especially when compared to certain competitors. The stock has done quite well YTD and the charts still favor the bulls. While the industry downturn continues, the trough may already be in if Q2 guidance is any indication.

On the other hand, there seems to be a disconnect between the health of the semiconductor industry as it is perceived by the stock market and the actual health of the semiconductor industry. The former has assumed the latter is about to go on an upturn, especially when looking at YTD returns for many semis, even though that does not appear to be warranted at this point based on the actual numbers. This disconnect may need to be corrected at some point.

Bottom line, while UMC has done well thus far in 2023 as far as the stock is concerned, it may be a different story in the coming months. The stock may have rallied too much based on overly high expectations of an industry recovery. If this turns out to be the case, the stock could easily give back some, if not all, of its gains. Caution is warranted.

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