2303 TT

Publicly traded companies mentioned herein: BestBuy Co Inc (BBY), United Microelectronics Corp (2303 TT, UMC)

Highlights

The presenter is short shares of United Microelectronics Corp (2303 TT), a Taiwanese semiconductor foundry. The pandemic caused a big pull-forward of demand for UMC products. Supply couldn’t catch up quickly enough after many years of capital under-investment by both UMC and other foundries. The short thesis is based on the expectation there will be a supply-demand normalization or a downcycle from here which will lead to a P&L mean reversion. The presenter expects the market to wake up to this coming downcycle by summer 2022 and for the stock to soon after be trading at 15x earnings multiple which would mean a stock price in the $30s per share vs. the current price of $57/share.

Because the pandemic-induced demand shock was met so poorly by the industry, there’s been a big overreaction by foundry companies to increase capex to add supply. The annual capex investment over the next four years is expected to be 3-4 times what was spent per year pre-COVID. The presenter believes that much of these supply additions are being fueled by geopolitical independence considerations as opposed to pure economic needs. Subsidy programs are expanding or increasing in the EU, US, and parts of Asia. The presenter believes that much of the capex coming is not really needed and therefore will serve as the basis for an oversupply downcycle beginning this year. 

The supply additions will start in the 2nd half of 2022 and then really ramp up in 2023. The presenter thinks big customers can see this coming already, will anticipate the overbuild, and, therefore, will not wait to ask for discounted pricing during the next round of negotiations. 

On the demand side, the end markets for UMC are TVs, smartphones, and PCs. The presenter sees softening very clearly occurring in TVs and smartphones. In PCs, while there’s not as much evidence of softening yet, there’s more downside risk than upside on that segment at this point. Google Trends, which admittedly is not the best indicator, nonetheless shows demand plummeting in all of these segments in 2022. Looking at BestBuy (BBY) in the US and comparable retailers in Europe, all are cautioning right now about softening demand across in 2022.

Globally, inventories across the semiconductor supply chain are now back to 2019 levels. Double ordering, which had been exacerbating the demand side during the pandemic, has ceased. This creates the risk of promotions coming back sooner than the market may expect. 

The presenter feels that management comments around demand in the most recent UMC earnings call were less confident than prior quarter calls, including their forecast that there will be oversupply at some point.

There are a few more modest price hikes coming which have been telegraphed to the market for some time now. Once those price hikes run their course, this next downcycle will begin rapidly.

Looking at the P&L, in 2022 he still expects sales to be 70% higher than pre-COVID levels due to higher unit sales and much higher ASPs flowing through the numbers. The presenter expects gross margin to be 40% vs. mid-teens (%) pre-COVID due to aggressive yet unsustainable ASP hikes. UMC, the presenter observed, has been hiking ASPs more aggressively over the past year compared to peers.

Regarding valuation, the company is trading at over 2x book value today vs. the historical level of 0.5x to 1x BV.