UMC Earnings: Undervalued Because Consumer Devices’ Green Sprouts Trump Auto Downside

Our fair value estimate for no-moat United Microelectronics Corp 2303, or UMC, stays at TWD 62 per share after minor changes. Management’s comments on consumer electronics demand bottoming and an unimpressive automotive outlook are in line with what other firms in our coverage have said so far. UMC’s shares remain undervalued, in our view, pressured by uncertain short-term automotive and industrial demand. We believe UMC is virtually unaffected by updated U.S. chip export rules as of Oct. 17, as its yet-to-ramp artificial intelligence-related products have little influence on chip performance.

Both revenue and profitability in the third quarter were above our expectations. Although capacity utilization fell 4 percentage points sequentially to 67%, revenue rose 1.4% sequentially to TWD 57.1 billion, and gross and operating margins were flat from the June quarter at 35.9% and 25.8%, respectively, due to the 4% appreciation of the USD against the TWD.

Fourth-quarter guidance is within our expectations, with the top line dropping 5% in USD terms and gross margin in the low 30s. Management projects utilization to trend further down to the low 60s from 67% as 8-inch wafer demand is affected by inventory adjustment in automotive products. Management did not say when the adjustment will end, but we think it is likely to last throughout the first half of 2024, as end demand outside of China is dampened by rising monthly payments (from higher interest rates) and high inventory levels implied by lithium battery production in China outstripping sales by up to 30%. UMC has been receiving rush orders related to PCs and smartphones, a sign of demand bottoming out. However, we think recovery remains slow, and so leave our 2024 estimates unchanged for now.

Consistent measured attempts to optimize 28nm capacity and ready 14nm capability are what we like about UMC compared with other non-TSMC foundries.