Company Background
AU Optronics (AUO) is a Taiwanese manufacturer of thin-film transistor (TFT) LCD and AMOLED displays. These flat panel display technologies are prominently used in products including televisions, smartphones, notebook computers, and tablets.
Recent Performance
AUO has enjoyed strong performance recently, beating earnings estimates four quarters in a row, with the last four quarterly estimates totaling just $0.04 and actual earnings totaling $0.27. This improved performance is a function of improved cost structure, as revenues grew 7.1% while OPEX fell by 22.0% and COGS fell by 4.0% in 2013. While AUO's financial performance has been historically weak in Q1, it was able to remain profitable in 2014, suggesting that significant earnings could be on the way in coming quarters. Analysts have taken note, raising EPS estimates by over 250% YTD to $0.26/share.
Despite this unexpectedly strong performance, the shares of AUO have appreciated only 25% YTD. With a forward P/E of 14.89, AUO is trading at the low end of its historical range and below the electrical component industry average of 23.28. While investors have some valid concerns for AUO moving forward, at its current price, AUO is an excellent value.
Growth Opportunities
In September of 2013, Cantor Fitzgerald analyst Brian White summed up sentiments that still linger about AU Optronics, writing, "AU Optronics is recognized as one of the leading LCD panel makers in the world and enjoys a rapidly growing franchise in the 4K TV market. Given the sluggish macro environment and the expiration of LCD TV subsidies in China, we expect muted LCD panel trends in the near term. Trading at nearly 0.60x tangible book value and near trough levels, we believe the downside risk is limited but a catalyst is difficult to find." The belief that there are few opportunities for growth seems common amongst industry analysts, but is misguided.
The forward-looking product line of AUO is a major source of potential growth that is not fully priced in. First, the 4K Ultra HD television market provides a major opportunity for AUO to grow revenue and expand margins. Second, the AMOLED display market for smartphones and notebooks has seen rapid growth in the past year, which is likely to continue. As a leader in both Ultra HDTV and AMOLED technology, AU Optronics is well positioned to grow over the next 6-12 months.
In order to understand AUO's growth potential, it is critical to understand the TV market as a whole. IHS reports show that this market is currently dominated by the LCD segment. In 2013, US TV shipments amounted to 34 million units, consisting of 31.9 million LCD TVs and 2.1 million Plasma TVs. Rear projection and CRT TVs were completely phased out. OLED TVs, which provide unrivaled picture quality and have been hyped as the next big product, have begun to enter the market in 2014, but are expected to ship just 8,000 units. The TV market as a whole is trending towards larger and higher definition TVs. DisplaySearch TFT analyst Robin Wu writes "With market competition focus shifting from 32" to 39", 40" and 42" range, as well as the 4K and curved LCD TV designs driving interest in 50" and above sized LCD TV panels, shipment area looks set to increase in 2014."
Though AUO is positioned as a leader in the small AMOLED TV market, its president, Paul Peng, believes that improving existing LCD technology is the key for success in the near future. He stated in a September 2013 interview that the expensive production process will likely prohibit OLED TVs from taking over the TV market. Instead, he believes the improved color saturation from new Ultra High-Definition (UHD) LCD TVs is the way of the future. The data support this conclusion, as annual UHD shipments in 2013 of 3.1 million are projected to soar to 15.2 million in 2014. Demand is expected to continue to grow to 68.4 million units by 2018, a 350% increase over 2014 demand.
The fact that growth in the TV market is coming from the UHD segment is a great sign for AU Optronics for a couple reasons. First, AUO is capable of producing UHD panels of quality that few companies in the industry can replicate. It became the first company to mass-produce large area curved LCD displays last year, when it produced 65-inch curved LCDs for Sony. Its product gives it an advantage over many Chinese competitors notorious for producing lower-quality 4K TVs. Second, UHD sales will have a positive effect on AUO's margins. Skeptics will rightly argue that margins will inevitably decline as more competitors enter the UHD market. However, it's important to realize that even a small margin increase would be leveraged by AUO's miniscule 0.27 price/sales ratio to produce a dramatic effect on the company's value. As the television market shifts towards larger panels and UHD TVs, AUO will thrive.
While the AMOLED TV market may never materialize into anything significant, the smartphone and notebook market for AMOLED displays is rapidly growing as mobile phone and PC producers seek to equip their products with high-resolution screens. AMOLED displays not only provide sharper pictures than LCD, but also are more effective at conserving energy, an important feature for battery-powered devices. AUO recently unveiled its Quad HD AMOLED display for smartphones. This is the highest-resolution OLED screen currently available, and is a major source of competitive advantage. AUO is extremely well positioned to profit as smartphone and notebook producers transition away from basic LCD screens towards ultra-high resolution 4K and AMOLED screens.
Overcapacity Concerns and Macro Risk
Flat panel manufacturing is a highly competitive industry that has been plagued by overcapacity issues. Competition is so fierce that in 2011 and 2012, weak demand resulted in AUO running negative gross margins. Investors' hesitation to place a large valuation on a stock that has performed so poorly in recent memory is understandable. The small margins and volatile demand inherent to the flat panel industry mean that AUO does come with significant risk. When demand for consumer electronics, falls even the best-positioned flat panel manufacturers will struggle. However, outlook for demand is fairly strong right now. While falling demand for televisions squeezed suppliers in 2013, the market is expected to grow in 2014. In March, the total large area panel shipment area reached a record high level of 12.5M square meters, and then in April, reached 12.3M, an 11% Y/Y increase. With the Gallup U.S. Economic Confidence Index increasing to -14 in May, its highest monthly reading so far in 2014, expect strong sales to continue in the short term.
Recommendation
At its current price, AUO is a great value. AUO is a strong candidate for price appreciation in the next 6 months, as well as a solid option to buy and hold for the foreseeable future. I expect that over the next 6-9 months, share price will reach $5.00, with upside potential of $6.00-$6.50 and limited downside risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
