MagnaChip's Impressive Strategy Change Delivers
- The company is producing an impressive change in strategy, concentrating resources and attention on higher margin business like OLED display drivers.
- The strategy change is already paying off pretty dramatically.
- We think there is upside in the shares, as the cost of the strategy change will fade and some headwind might also wither, while the improvements are likely to last.
We argued a while back that the shares of MagnaChip (NYSE:MX) were due for a bounce. Well, that bounce came and went, and now another one is underway:
The present bounce is powered by solid Q1 earnings, even if they fell a bit short of expectations. We're not too worried about that; there are some headwinds:
- Higher wafer prices
- Restructuring the display driver business
- Decline in the Chinese smartphone market
These are mostly temporary, and on the latter especially there is a lot of good news already.
There is a scarcity in 8-inch wafers, but the company is doing everything to opportunistically secure supplies, like:
- Entering into long-term contracts.
- Increasing buffer stock at attractive prices when possible.
The latter isn't immediately obvious from the balance sheet as there is a change due to the ASC-606 rule. Overall inventories actually went down 22.5% at the end of Q1 to $56.7M.
The company is making two shifts to address the low margins in their LCD panel driver business simultaneously:
- Reengineering their LCD driver business.
- Shifting toward OLED drivers.
The problem with their LCD drivers was that much of it commands paltry margins, and management has decided that they're going to prioritize profitability. What they're doing is:
- Introducing a platform approach to product development in which the LCD drivers share a common architecture.
- Not go after low margin business ($11M in the quarter).
- Transferring $4.4M of LCD driver business in Q1 and approximately $20M for the year in LCD driver business.
As a result, management expects their LCD driver business to decline by half from roughly $30M per quarter last year to $15M this year. Instead, the company is going all-in on their OLED driver business, and it's here where most of the good news is produced.
Management argues that they have created their own upturn, despite the above-mentioned headwinds, through the development of new OLED drivers that have already created a lot of traction. The company is well positioned:
- Strong relation with the two leading Korean OLED panel makers, a second one was added just recently.
- Rebound in the low to mid-end smartphone market where their market-leading rigid and rigid bezel-less OLED drivers thrive.
- The company also has a growing portfolio of flexible OLED drivers for high-end smartphones, "a market segment where we barely scratch the surface and represents a great opportunity." (Q1CC). At present, this high-end segment is a little soft but it's expected to pick up again.
- The company has expanded its OLED driver portfolio from 2 to 6 chips, 5 of which are already selling and the sixth one is underway. It's already working on the next generation of drivers which will work on 28-nanometer.
- More than 10 smartphone makers have awarded MagnaChip with 28 OLED design wins over the past three quarters, 10 of which in Q1 and management anticipates another 10 wins in Q2.
All this has led to a pretty dramatic improvement in performance:
- OLED revenue increased 141% sequentially and 112% y/y in Q1.
- OLED revenue has the potential to increase a further 50% sequentially in Q2.
- Management anticipates that OLED revenue will far surpass their previously stated revenue targets for 2018 and could approach the previous record set in 2016 of $160M.
The improvement is further enhanced by the fact that their OLED driver business generates above average margins, which will increase when the flexible driver business for the high-end models recovers.
The company has a couple of other businesses:
- Foundry, which showed a high 80s utilization rate.
- Power products.
The latter especially is also booming, over 40% of the products are in the premium segment and for the first time gross margin exceeded the corporate average as a consequence.
Growth here is driven by new applications, more especially in automotive, but also in the industrial sector and even the consumer sector.
These are GAAP margins, but the trend is upwards. Management expects margins to remain relatively stable as the boom times from OLED are balanced by the headwinds and the decline in LCD drivers.
Gross margin was 26.9% in Q1. In dollar terms, there are improvements though. Q1 operating income increased 15.9% to $7.4M and adjusted EBITDA income was up by 18.4% to $15.5M.
Management expects OpEx to run at roughly $37M a quarter, in Q1 it was a little lower due to a one-time benefit of $700K (recouping an insurance claim). It will likely increase due to increasing R&D for their OLED driver business. CapEx was $7.3M in Q1 and will be roughly $30M for the year.
Cash was affected by their bi-annual interest payment of $9.6M. Cash was $123.1M at the end of Q1, down from $128.6M in Q4 and $132.6M in Q1 2017.
While there hasn't been much in the way of dilution, debt has increased since the end of 2016.
Analysts expect an EPS of $0.78 this year, rising to $1.07 in 2019. Valuation doesn't seem stretched to us so we think these shares could run quite a bit further, at least on a valuation basis.
There seems to be a pro-active management at the helm of this company, not sitting idle in the face of headwinds but taking sensible steps to improve their business.
Which is what they've done, and the company enjoys an outlook that is considerably improved as a result, shifting resources and attention from LCD drivers to OLED display drivers has paid off handsomely already.
Their power business is another one where they are favorably positioned as demonstrated by increasing margins.
The shares have suffered from the feeble sentiment in semiconductor stocks recently, but as far as MagnaChip is concerned, this isn't warranted in our view. Today's 15% or so rally testifies to that, but isn't necessarily the end.
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