Stock Review: United Microelectronics Corporation (2303.TPE)

​Kevin Smith, of Delft Partners and portfolio manager of the TAMIM Asia Small Companies Fund, highlights one of the stocks in the Asia Small Companies portfolio. 

Author: Kevin Smith

United Microelectronics Corporation (UMC) manufactures and markets integrated circuits. The company provides wafer manufacturing, assembly, testing, mask production and design services. UMC operates 12 fabs that are located throughout Asia with a maximum capacity of more than 750,000 8-inch equivalent wafers per month. The company employs approximately 19,000 people worldwide, with offices in Taiwan, China, United States, Europe, Japan, Korea and Singapore. In Q3 2019, UMC ranked fourth in the pure foundry industry with 6.7% market share (source: Trend Force). UMC manufactures semiconductors using advanced production processes for customers based on its own proprietary integrated circuit designs. UMC’s wafer fabrication process include services such as design, mask making, testing, and assembly services. 

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Accounting, Strategy and Governance Comments

Accounting

​UMC has been audited by Ernst & Young since the year 2000, the engagement of a big name accounting firm is a positive.  With the listing of ADRs in the United States, UMC is subject to oversight from the Securities and Exchange Commission.  There have been no financial restatements or revisions since 2015.  UMC had one critical audit matter in their 20-F filing in April 2020 relating to the valuation of slow moving inventories, we are satisfied that the company has addressed this issue.

UMC has generally kept its debt levels ranging from 21% to 33.6% of assets between 2015 to 2019, very low by the standard of the industry.  UMC moved into a net cash position in 2019 and currently holds NTD 36.8 billion (equivalent to USD 1.25 billion).

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Source: Market Screener

Strategy
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Since the semiconductor industry is highly cyclical, UMC is exposed to periods of rapid expansion and contraction. Other factors that affect UMC sales are the worldwide demand for semiconductor products, pricing, worldwide production capacity, capacity utilization, technology migration and fluctuations in foreign currency exchange rates. UMC’s sales growth has expanded in the last five years by a CAGR of just 1.1%, while net profit declined at a CAGR of 2.7% during the period. However, we note that despite the slow historic backdrop for sales growth, net profit grew by 26.4% in 2019 and in the most recent figures for the six months to end June 2020 sales increased by 26.3% versus the equivalent period in 2019. 

UMC has a well diversified spread of customers. Asia Ex-Japan accounted for 55% of Q2 2020 revenue, North America 31%, Europe 5% and Japan 9%. Among UMC’s customers are Xilinx, Broadcom, MediaTek, Realtek, and Novatek, Texas Instruments, Intel Mobile and STMicroelectronics.

We believe UMC will transform into a specialty foundry changing its business model and focus on 28nm, 40nm and 8" foundry products, which will result in significantly improved profitability by reducing capex and R&D.  UMC is currently focusing on the production efficiency of its legacy nodes (above 28nm process) given the strong competition in the advanced nodes (less than 28nm process). Hence, it has been able to expand its wafer output capacity by 5%-6% annually from 2016 to 2019, while posting lower capex every year during this period.

Gross margin is likely to continue expanding into H2 and 2021, as 28nm helps the overall cost structure, and as depreciation expenses come off with lower capex. We expect UMC to reduce capex to US$800m vs. guidance of US$1bn for 2020. 

Governance

​UMC publishes their corporate governance policy (most recently March 2019) and maintains the standards required in Taiwan Stock Exchange Listing Rules.  The Board comprises nine Directors of which four are independent.  Directors serve terms of three years and can stand for re-election.   

UMC has been ordered to pay a fine of NTD 100m (equivalent to USD 3.5m) by a district court in Taichung City which found the company and three of its employees guilty in a trade secret theft case brought by U.S.-based memory chipmaker Micron Technology.  UMC has denied its DRAM technology is related to that of Micron.  Technology disputes of this type are “normal” in this industry and we don’t consider this to be a significant lapse in UMC’s governance.  UMC faces a bigger challenge with respect to the legal action taking place in the United States courts associated with its collaboration with Fujian Jinhua.

During the past five years, total dividend pay-out has averaged 75.6%, we expect the high payout ratio to be maintained. 

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Value, Momentum and Quality Comments

UMC has an overall VMQ score in the top 30% of our universe of companies with an especially strong score for value driven by the dividend yield in excess of 6% and price/book ratio of 1.0.

UMC’s return on equity is improving towards the 10% plus level, having been as low as 3% five years ago.  This improving trend for return on equity will help the score for quality, together with the strong balance sheet with net cash.

There are 20 analysts providing coverage of UMC, the second quarter results came as a complete surprise to the analyst community, beating their estimates by more than 50%. Net income for the six months ending 30 June 2020 increased from TWD 1,035m to 7,281m resulting in an eps uplift from TWD 0.25 to 0.74 for period. The positive surprise contained in those second quarter results has generated a significant uplift in earnings forecasts for 2020 and 2021 and underpins a strong and improving score for momentum in our VMQ analysis. 

Source: Market Screener