United Microelectronics stock is undervalued and a buy (NYSE:UMC)

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United Microelectronics Corporation (UMC) was in the limelight in March-April last year at the height of the semiconductor supply crisis, when it was able to secure advance payments from its customers, composed mainly of automobile manufacturers. It was something unprecedented before.

As a result, operating cash jumped to over $800 million at the end of the second quarter of 2021, as shown in the orange chart below, while revenue grew more strongly in the third quarter, the Taiwanese company having maintained the delivery of components to customers.

Data by YCharts

Now, in addition to automotive games, the company has also seen strong demand for chips in the computing, consumer, and communications segments with higher 12-inch wafer shipments in the third quarter of 2021. It has also benefited from an improved product mix which contributed to the increase in average selling price or ASP. As a result, gross margins and operating profit surged, culminating in a beating in profits.

Now, with fourth quarter results slated for January 25, my goal with this thesis is to provide some preliminary information on what to expect in terms of sales in an environment characterized by supply chain bottlenecks. supply and inflation, with UMC’s factories located throughout Asia. .

I first analyze return on capital, an area where smaller foundries have historically been disadvantaged relative to larger ones.

The return on invested capital

First of all, the way in which UMC was able to finance the additional investments made for its 28 nm production unit deserves particular attention. While its giant counterpart Taiwan Semiconductor Company (TSM), with a market capitalization of $613.4 billion, must mostly use its own funds, or get money from banks, and even rely on government-level subsidies. state for its relatively tiny US-based plant, UMC (with a market capitalization of $28.3 billion) was able to secure advance payment from automakers, which also allowed it to benefit from not only guaranteed orders , but also better prices.

At this point, a key metric is return on investment or ROIC. It’s more of a profitability ratio, but with the added benefit that it also measures whether a company has a moat, which signifies a strong competitive position. UMC’s ROI, while lower than TSMC’s, is growing rapidly as shown in the purple chart, meaning it is becoming more efficient in the use of capital.

Data by YCharts

On the other hand, it is a more delicate picture for TSMC which, after having achieved a return of more than 20% in mid-2020, seems to have some difficulty in increasing the efficiency of the capital invested. So while it may be far behind TSMC or even Samsung Electronics (OTC:SSNLF) in terms of the volumes of chips produced, UMC proves that it is possible to increase efficiency while operating on a smaller scale.

Additionally, this ability to deliver better capital returns over time is significant as the company has invested $2.3 billion in CapEx for chip production expansion in 2021 alone, or approximately 0, 37 times of its total sales which amounted to $6.297 billion for 2020. This represents a significant investment relative to sales, and I assess whether it has been productive by looking at revenue for 2021.

Dissecting the sales figures for 2021

Regarding the monthly revenue, which was published on the company’s website, it stood at NT$20.28 billion for December 2021, an increase of 32.65% compared to in the same month of last year. This increase is less than in November when an increase of 33.52% was obtained, but sales still increased on a quarterly basis as highlighted in yellow in the table below. So the sales for the fourth quarter were NT$59.1 by my calculation.

All figures are in NTD.

Monthly, quarterly and annual net sales

UMC company website

Relative to the industry, according to monthly data released by the Semiconductor Industry Association (SIA), global chip sales rose 23.5% year-over-year in November, translating into a up 1.5% month-on-month (October-November). That’s less than UMC’s 33.5% YoY and 2.6% MoM respectively, meaning the small Taiwanese foundry operator is growing at a faster rate than the industry.

Extending the comparison specifically with TSMC, while the latter’s October-to-November and November-to-December increases in chip sales of 10.2% and 4.8%, respectively, were greater than UMC’s, the Taiwan’s smallest game still managed to deliver better overall growth for 2021. Thus, its total sales for 2021 were higher than 2020 by 20.47%, surpassing TSM’s 18.5%.

Although that may not mean much in terms of absolute numbers since TSM’s total sales for the past year at NT$1.59 trillion are 7.45 times the NT$213 billion of its smaller counterpart. , this makes sense for valuation purposes where revenue growth is a key metric.

Evaluations and key points

First, for clarification, the annual revenue growth figures provided in the table below are for 2020 and at that time UMC was showing a lower growth rate. However, things have now reversed and for 2021 UMC has grown faster, by almost two percentage points.

compare with TSMC

Comparison of metrics with peers

Looking for Alpha

Therefore, this means that UMC’s valuations at a price-to-sell ratio of 3.81x also need to be adjusted. So, adjusting for a modest 5x given the current market volatility for tech stocks (in the context of growth-to-value rotation), I get an estimate of $14.5-15 based from the current stock price of $10.88.

Target stock price = 5/3.81 x 10.88 = $14.27.

Coming back to ROI, it is also expected to continue its upward trend according to executives, wafer shipments with ASP (in US dollars) are expected to increase in 2022 while the capacity utilization rate (capacity utilization of foundry production) is expected to be 100%. At the same time, demand is increasing and the company has been able to offset the increased cost of raw material (raw wafer) and labor through improved production efficiency. .

Adopting some caution, the company also experienced component shortages, but these did not impact production. In addition, inventory levels reached $831.3 million or NT$23 billion at the end of the third quarter, a record high. That shouldn’t be a problem as long as demand remains robust. To that end, UMC is diversified, with approximately 65% ​​of its revenue coming from the Asia-Pacific region in the third quarter, followed by 22% from North America, and the remaining 15% from Europe and Japan. . I also found that the inventory as a percentage of total assets was 5.40%. This means that the company has a relatively small percentage of its fixed assets in inventory.

Finally, operating mostly in the shadow of TSMC in terms of revenue, UMC has now taken the upper hand in terms of growth while rapidly increasing efficiency in the use of capital. This is not only synonymous with better profitability but it is also a useful criterion used by financial organizations to allocate capital in sectors where CapEx tends to be very high. UMC also pays a higher dividend yield than its giant counterpart and its free cash was NT$113 billion (about $4 billion) at the end of the third quarter after paying distributions to shareholders.

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