"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."
On the morning of August 15, HIMX reported Q2 sales of $207 million, up 9% from $189.5 million in Q2 of 2012. Though higher than any quarter since 2008, its Q2 revenues were $1.6 million shy of Wall Street expectations. On a bright note, adjusted earnings were 11 cents per share, beating Street expectations by a penny.
HIMX stated that large-panel IC drivers and sales to Innolux were to blame for the top-line miss. This validated the checks into Asia that were provided by PoisedToTriple Research ahead of HIMX's Q2 report.
HIMX management also stated that small and medium-sized panel driver demand was coming under pressure, which will impact Q3 sales. Its guidance calls for $182 million to $197 million, below current analyst expectations of $218.8 million.
Despite the rough patch in top line demand, HIMX continues to do well in higher-end product lines. This is driving higher profitability and will enable EPS to hit 10 or 12 cents per share in Q3, higher than Wall Street expectations of 9 cents per share.
In pre-market trading, shares of HIMX fell some 7%. However, PoisedToTriple Research upheld its "Gold Mine" rating of the company, due to strong earnings performance and growing momentum in non-driver businesses. Revenues from Himax's non-driver business, which include CMOS image sensors, LCOS microdisplays, touch panel controllers, power management ICs, LED diver ICs, wafer level optics, timing controllers, ASIC services and IP licensing, were $31.8 million, up 22.3% versus Q2 of 2012 and 30.4% versus the March quarter. This represented 15.3% of HIMX total revenues.
We expect this revenue contribution to grow significantly in the coming quarters and years. CMOS image sensors are experiencing positive trends, as the company gains traction in the 1, 2, and 5 megapixel markets and ramps its newly-launched 8 megapixel sensor. Further, 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). We believe this will be driven by Google (GOOG) Glass and several other vendors that we expect to enter the "glass" market. Among these, we highlight Microsoft (MSFT), whom we believe will use HIMX's technology in its upcoming Xbox glasses.
Once HIMX ramps to 25 million units, we expect the company to 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). This will drive a 200-500% increase in non-driver revenues.
Based on our proprietary research on HIMX's LCOS margin profile, we believe that HIMX's EBITDA on 25M units would be on the order of 75-cents per share. Needless to say, the impact of adding 75-cents of EBITDA is material to the stock. Not only will it represent higher EPS, it also implies a higher growth rate than Wall Street is expecting. Street estimates call for 63-cents of EPS in 2014, up 46.5% from 2013 and up 9-cents (+17%) since our prior EPS analysis. Adding 75-cents to 2013 EPS would result in $1.18 of EPS, nearly double the 2014 estimates. To be clear, this is medium-range target, but illustrates that HIMX possesses a clear and robust growth path for the next several years.
Indeed, current estimates can justify a $15 valuation by applying a 0.5 PEG ratio to 2014 growth and earnings. This signals that shares of HIMX remain undervalued. These sentiments were echoed in HIMX's recent investor presentation, where it highlighted its "low P/E compared to peers.
That being said, shares of HIMX are unlikely to make progress toward that goal today. Investors are interpreting the Q2 earnings report and Q3 guidance negatively. As stated in our Q2 preview, we believe that to be a short-sighted view:
"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."
We also stated that investors "should care less about the income statement and more about what management says on the conference call". From that perspective, we were amply satisfied with management's optimism. Investors have the right to buy or sell their shares at will, but we believe that HIMX's long-term prospects will reward those who buy or hold and current levels.
For those looking for an entry point, the $6.10 range may provide some previous-price support, along with its 50 day moving average. Many factors may contribute to near-term price stabilization. First, the shares experienced a sharp pullback ahead of the Q2 report. Further, the company has a buyback program available for use. Finally, HIMX will host investor meetings and attend an investor conference in the New York Metro, Boston and Chicago areas from September 17th to September 27th.
Taking all factors into consideration, we reiterate our stance that Q2 represented the past for HIMX (and Q3 only represents the near-future). Beyond Q3, we believe that driver and non-driver trends will accelerate, setting the company up for a strong 2014 and beyond. We look forward to optimistic Q4 guidance on the Q3 earnings call and continue to believe that shares of HIMX are poised to triple.