Re-Examining LG Display, And The Ramp-Up In China

Summary

• The fortunes of LG Display are tied to the evolving state of the display industry. I see Apple in a similar light.
• The recent move in LPL shares was due to market recognition of some developments and ignorance of others.
• I'll also re-examine Apple's relationship to the broader market.

It's been almost exactly two years since I published my Top Idea article, "Why Now is the Time to Buy LG Display" and those who acted have realized about 60% return on capital.

It's been something of a rocky ride, though, and three more Pro articles have followed, each citing a different buying opportunity which resulted in even greater gains on annualized basis. This article will be different. It explains why I liquidated the last of my long LG Display (NYSE:LPL) positions over the past month and am discontinuing coverage of the stock in my services. I will also re-examine Apple's (AAPL) relationship to the industry and broader markets.

Recent News and Stock Movement

Just before Independence Day, Korean reports that Apple might subsidize AMOLED production at LG Display began making their way across western news sites. The news had little effect on LPL, though, as the stock declined marginally for the day. An understanding of the Korean press is crucial to assessing the impact of news like this. My view is that the news lacked impact because the market has regarded such an agreement as a near certainty for a long time now. I know I have done so since the beginning, and I've updated that outlook on several occasions as the situation dragged on longer than it should have. Word is that LGD is now soliciting the investment, which will probably result in worse terms than it might have if an agreement had been reached before the Samsung deal and expansion were official. Apple's sub-par experience with the AMOLED watch face supply from LG Display, where only a third or so of capacity turned out to be usable, can't have helped matters either.

Instead, the rapid ascent in LPL began a month earlier, when news broke that LGD would begin prioritizing mobile AMOLED displays above televisions in next year's new production lines. That was the real signal that a second-sourcing deal with Apple was near, but I immediately identified it as a complete misread from the market. What wasn't picked up by any mainstream news was the reason for this decision, which was a demonstration from BOE, the leading Chinese screen manufacture, at Display Week, the premiere technology event for the industry. BOE showed the world's first emissive QLED prototypes at SID. Although the screens were fairly low resolution and only 5 and 14 inches, they were produced entirely via inkjet, which my long-time readers will already recognize as a transformative technology for AMOLEDs. That this milestone should come from a Chinese company, rather than a Korean or Japanese one has profound implications, one of which is applicability to TV manufacturing, and thus the end of LGD's monopoly in that segment.

The other piece of news that may have been holding LPL back is the closure of one of its main production lines due to a fatal accident, but this went virtually unnoticed in western news. The price effect is more likely coming to LPL ADRs via the relative pricing of the Korean shares, than from direct recognition in the west. The last time something like this happened, the shutdown duration was less than a month, but it's conceivable that a changing Korean government could take a different approach this time around.

The Writing on the Great Wall

Some are seeing such political change in Korea as opportunity, but I think it is too little, too late. China's AMOLED screen capacity is set to double each year for the next 3 years, rising to more than half of Korea's planned production, even with LGD focusing all of its new capacity on AMOLEDs. The ramp in China is no longer just rumor and press releases, with plant construction now in progress. Korea's historical quality lead is also eroding faster than predicted, and Japanese providers are now beginning to supply high resolution equipment to Chinese producers. That leaves LG Display caught in the middle, where it can not currently compete with Samsung's absolute dominance in mobile AMOLEDs, and would not have time to recoup its investment in any further new construction.

Apple actually has the same problem as a customer and is now forced to rely primarily on its main competitor, just as I predicted. It's ever-vague augmented reality plans, are geared toward using micro-LED instead. However, while I find the direction plausible, I very much doubt the speculated 2018 time-frame. Traditional techniques can not produce full-color micro-displays with sufficient resolution and response times. My service has identified 4 stocks that may embody the micro-display opportunity. However in all but one case, which diverges from what we know about Apple's approach, they are still years away from potential commercialization. It is seeming progressively more likely that Microsoft (MSFT) will beat Apple to the punch with a mainstream product, using an alternate approach. As a result, Apple's own job postings show that the next product wave is still foldable devices, rather than augmented reality, leaving Apple captive to its main hardware competitor on its most expensive parts for years to come.

Behind all these developments is unrivaled Chinese government backing, and consensus on the viewpoint that I began offering over 3 years ago, that AMOLEDs would gradually take over the display industry. Japan continues to plan its next-gen efforts as well, though even that now has Chinese ties. All of this makes me skeptical of press regarding American production prospects, again with Chinese backing. China is famous for its horrid working conditions, and LGD's recent news and history indicate that even if such jobs were to come the U.S., they wouldn't be good ones.

Other Factors, Risks and Implications

Timing is usually one of the most difficult parts of investing, but immediate indicators for LGD's legacy markets are unfavorable, although the results will be mitigated by the company beginning to realize sales of AMOLED TV panels to third-parties. LCD panel prices have been falling, starting with mobile screens from the beginning of the year, and followed by their larger brethren in the last few months. Although LG Display is still somewhat insulated from these trends by the scale and technology differentiation that I cited in my original article, IHS estimates that its revenue for the first two months of the second quarter comes to $3.86b, which is well behind the pace of 1Q17. That in turn was not as good as 4Q16. There is some seasonality involved here, but if you look at my comments from each report, you can see a trend forming, and more importantly, LG Display's management being forced to continually adjust its approach in the face of surprising new competition.

The recent trend in panel prices should prove even more harmful to smaller legacy manufacturers like AU Optronics (OTC:AUO) going forward. The stock has offered up to 60% profit since my Pro article at the end of 2015, and again, greater annualized RoI to those who heeded my update article in advance of the dividend last year. More recently, though, I've warned subscribers not to chase the share price into this year's dividend, as the rebate rate clearly indicated that AUO was experiencing a minor short squeeze. Now that the dividend is past, I expect the share price to recede. It should be clear by now, though, that Apple desperately needs a (non-competitive) screen technology partner. My theory on that could still pan out for AU Optronics, but recent developments make it seem that Japan Display is at least as likely to fill that role, very likely with Chinese production assistance.

The one thing that could short-circuit a lot of the technology analysis presented in this article is a meltdown in Chinese funding. That is a very real possibility, but such an event would have excellent chances of spilling over into global markets, which would be just one more reason to sell the current run-up in LPL. I've detailed my reasons for being cautious about the U.S. stock market to subscribers as well, and one of them is the threat that the combination of low volatility and U.S. policy uncertainty poses to Big Money institutions. At roughly 10% of the Nasdaq's total market cap, AAPL is once again positioned as a poster child for general market risk.

Conclusion

LPL still appears to be reasonably valued by traditional, trailing metrics, but that's no reason to hang on to them instead of putting money to work on better options. I now see the stock as a value trap. LGD has both immediate and long-term problems that are tied to macroeconomics and poor governance in Korea. In each case where I've updated my outlook, there was a lag before the market came around to my point of view, but I can easily see LPL declining back towards single digits within a year or two.

With regards to Apple, which I also see as a value trap, its problems are of a more chronic, corporate culture nature. For the near term, its nominal stock price will depend more on the broader market, where there are plenty of reasons to worry. However, as consumer markets shift away from slab phones, its margins will come under increasing pressure. Investors need to look deeper than superficial trailing metrics and passive investing if they want to beat the market, which is something an increasing percentage will absolutely need to do if they want to be able to continue buying iPhones.

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Analyst’s Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.