PSSI Drops 2% on Morgan Stanley Report, Significantly Underperforms - DSCC Says Not a Turning Point as Earnings & Revenues Will Grind Higher on Richer Product Mix, Stable/Rising Prices and Lower Costs
On a weekly basis, I try and explain display stock price movements in our weekly newsletter. Last week was a particularly difficult week for display stocks, so I thought I would try and explain what happened and why it may be unwarranted.
The Panel Supplier Stock Index (PSSI) fell 2.1% the week of February 6th – February 10th while the US large cap stock index (SPY) rose 1.2% and the emerging market index (EEM) rose 1.2% as shown in Figure 1. As indicated in Figures 2 and 3, only CPT and BOE enjoyed stock price appreciation last week, up 3% and 1% respectively. Meanwhile, 5 suppliers – AUO, Innolux, Japan Display, HannStar and LG Display – suffered declines ranging from -3% to -7%. What happened? There were two reasons for the decline. First, the dollar strengthened after weeks of declining on signals from President Trump of significant corporate tax cuts and tax reform combined with infrastructure spending which could accelerate US market growth and inflation. As a result, last week the $US gained:
Overseas company market values typically fall when the dollar strengthens, as their businesses are then worth less in $US. However, this is offset by anticipated higher export opportunities as their products get priced lower in $US which benefits exporters. The 2.2% decline in the $US from Dec. 30th through February 3rd, helps explain the 11% increase in the PSSI over that time. If the dollar continues to recover and gain ground, the PSSI will likely lose ground. However, the 0.9% increase in the DXY doesn’t explain why 5 display stocks suffered 3% - 7% declines last week alone.
Figure 1: Panel Supplier Index vs. S&P and EEM (5/2/16-2/10/17)
Figure 2: Latest Panel Supplier Stock Index Results (5/2/16 – 2/10/17)
Figure 3: Feb. 6 – Feb. 10 Display Company Stock Price Performance
The large declines in display stocks can primarily be attributed to a Morgan Stanley report that double downgraded LG Display’s stock from a Buy to a Sell on February 6th, and was widely reported by Barron’s. The Morgan Stanley report includes Figure 4, which shows that panel price increases slowed to 1% in January. Morgan Stanley interprets the slowing price growth as a sign that the market has peaked. Shawn Kim from Morgan Stanley wrote that
“Supply is unlikely to tighten for 40”+ panels following aggressive customer inventory restocking after LCD capacity closure and elevated panel prices impacting demand elasticity. Chinese 8G fabs incremental output should ramp up from 2H’17, while pricing of small-size panels may prove hard to maintain, as we anticipate a reduction in utilization when OLED smartphone builds begin in 2H.”
As a result, Morgan Stanley lowered the price for LG Display’s stock on the KOSPI to 26,000 Won from 29,550 Won, implying a 12% price cut.
From our standpoint, it is early to make that call. 2017 will clearly be a profitable one for panel suppliers and 2018 should be profitable as well. First, panel prices are still rising. Yes, the ASP growth has slowed, but we are still seeing price increases. Witsview reported on February 20th that 49”-50” prices were still rising and reported no price reductions. Innolux said in its earnings call that 50”+ prices were still rising nicely. Companies reported blended double-digit price increases on an area basis in Q4'16. Innolux reported a 15% Q/Q increase in blended ASPs in Q4'16, LG reported a 16% increase and AUO reported an 11% Q/Q increase. With February prices significantly higher than October prices, etc., it is hard to believe that ASPs will decline Q/Q in Q1'17. So, profit margins should improve further in Q1'17 as costs also fall.
Figure 4: Blended Large-area M/M Price Changes
Second, the mix is still shifting to larger sizes and higher resolutions. Innolux indicated in its call that it expects its average TV size panels to grow by 2.5” in 2017 with the industry average growing around 2”. LG calculates demand rising by 5% on an areas basis in 2017. In addition, as we show in the next article in our 2/3/17 issue of The Display Supply Chain Monitor, blended ASP growth actually improved for all Taiwan suppliers in January on the mix shift from small/medium to large-area and within those categories themselves.
Third, there is minimal supply growth expected in 2017. Both LG and Innolux have stated in their earnings calls they expect supply growth to be modest. Innolux indicated low-single digits and also said it expects 50”+ demand to be very tight in the next few quarters. As a result of this continued demand for larger sizes (50”+) and higher resolution (4K and 8K), Innolux even indicated 2018 does not look too bad. They expect to remain profitable as costs continue to fall.
Fourth, yes, costs are falling and should fall faster than prices throughout all or most of 2017. So, we expect to see margins continue to expand in 2017. As shown in Figure 5, gross and operating margins are up nearly 100% from Q3'16 to Q4'16 with Q4'16 based on the companies who have reported so far - LG Display, Samsung Display, Innolux and JDI, and we expect them to stabilize at these or higher levels for the rest of the year.
Figure 5: Gross and Operating Margins, Q1'14 - Q4'16
Source: DSCC's Quarterly Display Supply Chain Financial Report
Do improved margins and earnings deserve a sell call? We don’t think so. Panel suppliers are shifting to a richer product mix, which should keep blended prices up. They even re-accelerated in January for Taiwan suppliers. We see panel supplier revenues grinding higher, and earnings continuing to grow as brands and consumers demand larger and higher resolutions across most categories.
Financial analysts are divided on the panel supplier outlook. As shown in Figure 6, BoAML believes operating margins haven't peaked yet, they expect them to peak in Q2'17 and remain at elevated levels throughout 2017 and 2018. On the other hand, JPMorgan expects a sharp decline in operating margins although still positive.
Figure 6: AUO Operating Margin Forecast
Source: JPMorgan and Bank of America Merrill Lynch
From our standpoint, the outlook remains healthy in large-area panels until 2019 when multiple 10.5G fabs ramp, which could worsen in 2020 when even more 10.5G capacity comes online. However, we expect a number of older fabs to continue to come offline as that happens. In addition, 10.5G fab ramps should be limited by Nikon lens capacity, which could significantly delay and capacity ramps for the latecomers. See this article/blog for more info.
In the case of small/medium panels, yes, there is a lot of OLED capacity coming online. However, the entire smartphone market will eventually shift to OLEDs, especially when flexible OLEDs come to market resulting in more rugged, lighter, larger and foldable/rollable smartphones. The demand for OLEDs will be high, so we don’t necessarily see significant price reductions in OLEDs until 2H’2019 or even 2020. OLEDs are the best thing to happen to the smartphone industry enabling smartphone suppliers to raise prices based on the OLED performance, size and form factor. Demand should be very high and supply will be constrained until the smartphone market is saturated with OLEDs. This phenomenon has occurred in TVs and in desktop monitors before it with LCDs and CRTs. This will be similar as smartphone brands will look to migrate as quickly as possible to enable higher prices. There will be lots of room for differentiation based on form factor, and average sizes will grow which should keep blended prices high. Panel suppliers will also be able to price higher and enjoy higher margins. There is a substantial difference between LTPS LCD and flexible OLED panel prices. However, unlike TVs which are very price sensitive, consumers can justify spending more on smartphones due to their critical nature and that they are paid off in payment plans, plus there is a large commercial smartphone market as well.
TThe outlook is less rosy for LCD smartphone panel suppliers. When there is enough OLED smartphone supply, what happens to LCD smartphone suppliers? There will always be demand at the low end of the market for less expensive feature phones and smartphones. As other suppliers chase more advanced smartphones, companies like HannStar and CPT are making a killing in the feature phone and low-end smartphone market where there are shortages. However, at some point, this market will be served with OLEDs or LTPS LCDs rather than a-Si LCDs that could eventually cause a-Si LCD suppliers to have to exit this market. When this happens, we would expect to see more fab closures or repurposing of those fabs to OLEDs or LTPS LCDs. LTPS LCDs might eventually have the same problem when there is sufficient flexible OLED capacity to service the low end market, unless JDI and others create flexible LCDs or flexible organic TFT LCDs. These and other similar subjects are explored in our Quarterly OLED Supply/Demand and Capital Spending Report.
Back to last week’s results,
This blog is an excerpt from the February 13th issue of The Display Supply Chain Monitor. Contact firstname.lastname@example.org for a sample issue.