"Shares of Himax (HIMX) have experienced an incredible start to the year. Since we initiated coverage on March 4th, the shares have more than doubled, hitting a fresh 52-week high of 7.10 this morning…the cat is out of the bag. Accordingly, in our latest Stocks To Triple Update (issued last night), we shifted our classification of HIMX from "Great Find" to "Wait Time".
This is how we opened our Q1 earnings preview for HIMX. That day, the shares fell 9%. A couple weeks later, the stock rallied to a 52-week high of $8.19, but that was its last gasp for the time being. In the months that followed, HIMX shed more than 40% of its value.
That all changed a few weeks ago when Google validated our prediction and announced that HIMX would be the microdisplay supplier-of-choice for the hotly anticipated Google Glass. Over the next couple of days, shares of HIMX gained 40%, as investor enthusiasm reached a fever pitch.
From our perspective, the positive reaction was justified. Himax reached out to me after the announcement to offer congratulations and some Q&A time. From that call, I gleaned that the company has medium-term plans to expand its microdisplay manufacturing capacity to 25 million units per year (up from 2 million units last year and about 3.5 million at present). Indeed, Google Glass isn't the only customer HIMX will need to service. We believe that several vendors will jump into the "glass" market, along with other augmented-reality offshoots. Among these, we believe Microsoft (NASDAQ:MSFT) will use HIMX's technology in its upcoming Xbox glasses.
Once HIMX ramps to 25 million units, we believe the company will generate $10-$20 per microdisplay (some microdisplays will come with additional functionality, partly accounting for the wide range). At either end of the spectrum, HIMX will be generating a tremendous amount of new revenue ($250-500 million) in a business that is nearly meaningless to HIMX at present.
That last sentence is critical for investors to comprehend. Despite HIMX's obviously bright future in the microdisplay market, that business is not currently big enough to move the needle. In other words, the success of HIMX's Q2 will be largely judged on the basis of its core businesses.
From that perspective, we believe there is cause for cautiousness (not panic, but cautiousness). Recent checks into Asia by PoisedToTriple Research suggest that demand for medium-sized panels (used in iPads / other tablets) and large-sized panels (used in notebooks and flat-panel televisions) experienced weakness in recent months. Demand for HIMX panel display drivers is directly impacted by demand for panels and represents about $150 million of its total quarterly revenues. By comparison, its non-driver businesses are only in the range of $25 million per quarter.
Further, Innolux (HIMX's largest customer) didn't fare too well in Q2. Investors should understand that while HIMX has done a masterful job of diversifying its business away from Innolux, this customer still represented over 30% of sales as of the end of 2012.
Does this mean that HIMX's Q2 results will disappoint investors? Not necessarily. We believe Himax has been gaining in the driver business, which could offset the relative/seasonal weakness in industry-wide panel demand. HIMX remains on the leading edge of technology, with particular strength in producing high-speed interfaces and 4K TV.
Which factor won the tug-of-war in Q2? We won't know until HIMX reports its results. Unlike a company like Tableau (NYSE:DATA), where Pipeline Data's Q2 reads were universally positive, the Himax tea leaves are difficult to translate. This should tell investors that unbridled exuberance is unwarranted in the short term. However, the positive long-term thesis remains intact, regardless of tonight's results.
Figuring out how to play it is simple to think through - investors need to understand why they own stock in HIMX and act accordingly. If you own HIMX because you "hope" the quarter will push the shares higher, understand that "hope" is not an investment thesis. If you own HIMX because you believe in its prospects for Google Glass (and other microdisplay-dependent products), I will tell you the Q2 numbers are irrelevant to you. In other words, don't worry about it either way.
In other words, sometimes the best call is not to make one.
Of course, many investors will gamble on how things will play out tomorrow. Half of them will be right by default, not by virtue of clairvoyance. Indeed, the only thing clear is that investors should care less about the income statement and more about what management says on the conference call.