United Microelectronics Corp. (UMC, Financial)(TPE:2303, Financial) is the third largest chip foundry in the world behind Taiwan Semiconductor (TPE:2330, Financial) and Samsung (XKRX:005930, Financial). However, while Taiwan Semiconductor has a market capitalization north of $500 billion and Samsung is valued close to $350 billion (when translated to U.S. dollars), United Microelectronics is priced at just $21 billion. Is it really that much less valuable to the semiconductor industry, or is the market undervaluing it?
Established in 1980, United Microelectronics has become a leading player in the industry, providing services for the design, manufacture and distribution of integrated circuits (ICs) for customers worldwide across a wide range of sectors, including communications, consumer products and services and industrial goods. Based in Taiwan, the company has total of 12 fabs in operation with combined capacity close to 850,000 wafers per month. Some of the past and present customers are rumored to include names such as Advanced Micro Devices (AMD, Financial), Broadcom (AVGO, Financial), MediaTek (TPE:2454, Financial) and Texas Instruments (TXN, Financial).
Not the best start to 2023
On Jan. 6, United Microelectronics reported net sales of $2.21 billion and earnings per share of $0.25 for its fourth quarter of 2022, missing on both top and bottom lines, with the guidance calling for a decrease in wafer shipments and for gross profit to come into the mid-30’s where historically it has been above 40%. A month later, the company reported that net sales for January were down 4.31% - a sharp contrast to the company’s December results where sales had been up 3.29% year-over-year.
That being said, United Microelectronics still has more than 7% of the total global market share. Essentially it does the same thing as Taiwan Semiconductor, but without the same high profile client roster. Obviously, there’s an argument as to why Taiwan Semiconductor is able to attract and retain those big name clients, and I get that; however, while it has seven times the market share of United Microelectronics, it is priced at 25 times the value.
By the numbers
From a financial standpoint, United Microelectronics seems like a no brainer value stock. Annual sales are estimated to grow beyond $10 billion by 2025 with profit margins remaining around 30%, which means it’ll likely book over $3 billion a year. Factor in the net cash position which places the enterprise value at $17 billion and that’s nearly an 18% annual return potential.
United Microelectronics has also paid out a dividend since 2005. Dividends are paid out once a year, usually in the summer months, typically July, but United Microelectronics is not just an income investment. The company can pay out a portion of its earnings and still generate a 17% return on assets and a 28% return on equity, which is very impressive. You may think the dividend would be low, but that's not the case - the forward dividend yield is an excellent 6.09%. More importantly, the semiconductor industry is not one that looks to be slowing down on the long-term outlook.
While some companies waste profits on unproductive reinvestment, United Microelectronics is able to give back to shareholders and still be in a position to grow. Could the company use those profits to buy back shares and improve the share price? Sure, yet this looks more like a situation where growth can be achieved despite producing income for shareholders. That means down the line, in three or five or even 10 years from now, the dividend could be much higher.
United Microelectronics has 2.1 billion shares outstanding and nearly $6 billion in cash. I believe it could (maybe even should) buy back some of its stock to boost earnings per share as well. At some point, it’s just not possible to produce the same level of financial performance no matter how much money is thrown into chip manufacturing. If 2023 turns out to be a tough year for United Microelectronics, then management could make those adjustments.
Still a growth story
The real risk is more connected to the history of share price fluctuations to the company’s underlying business results. From 2013 to about 2020, the stock price hovered around $2 per share, never moving more than 50% in either direction. Then, in 2020, the demand for chips saw a significant jump during Covid, especially for United Microelectronics as it made some strategic acquisitions. Total revenue is on track to double from 2019 and cost of revenue has only increased about 17%, and the result was net profits went through the roof. This looks like the trend for the foreseeable future.
While the semiconductor industry is correlated to the broader economy, bringing recession into play, the desire for new technology reliant on the industry is only going to rise in the future. The world depends on semiconductors in the same way it depends on energy. As the third largest firm in the industry, United Microelectronics should continue to benefit from this growth, and in the event Samsung or Taiwan Semiconductor falters, it could take more market share.
Conclusion: a bargain
The market is placing much higher value on United Microelectronics' two larger competitors, with the pure play Taiwan Semiconductor trading at 20 times the valuation of United Microelectronics while only generating seven times the sales and 12 times the profit. Granted, Taiwan Semiconductor is able to produce a lot more semiconductor wafers than United Microelectronics, thus the bigger brands will always turn to it over its smaller rival. That does not mean, however, that there won’t be a place for the third largest firm in the industry. Even its closest competitor GlobalFoundries (GFS, Financial), which went public in 2021, has a market capitalization that is $10 billion greater than it, and it has a much weaker financial position and is far less profitable. The bottom line is that when comparing apples to apples, United Microelectronics looks undervalued by nearly $10 to $20 billion.
