Bernstein: UMC bets 8.2 billion dollars on AI capacity expansion, while near-term price increases and gross margin fall short of expectations

Why did the third quarter fall short of expectations despite growth?

UMC reported third-quarter revenue of 74.239 billion New Taiwan dollars, up 8% quarter over quarter, but 2.1% below Bernstein’s forecast and 1.1% below the Bloomberg market consensus. Gross margin was 34%, about 1.6 and 0.6 percentage points below the respective forecasts; Bernstein believes weaker-than-expected average selling prices may have been the main reason.
In US dollars, the average selling price rose just 0.6% quarter over quarter in the third quarter, which the firm believes may have benefited from an improved product mix. The company guided for pricing to remain firm quarter over quarter in the fourth quarter.
At the midpoint of guidance, fourth-quarter revenue is approximately 2.379 billion US dollars, up 2.5% quarter over quarter but below the market consensus of 2.446 billion US dollars. The gross margin guidance midpoint is 34%, also below the consensus of 35.3%.

Growth in 2026 was driven primarily by shipments. Despite strong demand for power management, FPGA and optical connectivity products, Bernstein expects shipments to reach the capacity ceiling next year.
The company expects average selling prices to rise 10% year over year in 2027, driven by price increases for like-for-like products and an improved product mix. Capacity utilization had already risen to 92% in the third quarter, with fourth-quarter guidance holding just above 90%.
In non-AI businesses, automotive and industrial demand is recovering healthily, while demand for smartphones, PCs, LCD controllers and Wi-Fi remains weak. Management believes exposure to high-end smartphones and gains in foundry and customer share can mitigate the impact of weak consumer electronics.

Following approval of an additional 3.2 billion US dollars, UMC plans to invest a total of 8.2 billion US dollars to build monthly capacity for 18 thousand silicon photonics wafers, 22 thousand DTC wafers and 20 thousand thin-film lithium niobate modulator wafers. Equipment installation will begin at the end of 2028, with full capacity reached in 2030.
The company expects AI’s share of revenue to rise from about 3.5% to more than 25% within three years; AI revenue currently stands at approximately 300 million US dollars. Management’s confidence stems from its silicon photonics projects reaching milestones with several major cloud providers, mobile DTC entering mass production this quarter, and the validation and yield performance of other products.
Bernstein believes geopolitical factors help alleviate Chinese competition, but whether AI investment remains at a high level in 2029–2030, and whether competition intensifies by then, will affect returns on the expansion.

The market consensus expects UMC’s gross margin to rise from 33% in 2026 to 38% in 2027. Although the company cited price increases and higher utilization, it also said rising depreciation and material costs could make it difficult for gross margin to approach its previous peak. Bernstein’s own forecast for 2027 is 36.5%.
Bernstein expects further earnings estimate cuts and maintains its Underperform rating and target price of 103 New Taiwan dollars, implying approximately 20% downside from the closing price of 128 New Taiwan dollars cited in the report. Better-than-expected progress or pricing in 28-nanometer technology, an end-demand recovery and Chinese competitive pressure are upside factors for its target price.