LPL - Why LG Display Is Being Given The Benefit Of The Doubt

2023-04-28 10:21:43 ET

Summary

• LPL posted a bigger-than-expected Q1 loss, but there is reason for optimism with positive signs to be found in the display market.
• While the market for display panels is improving, there are a number of potential wildcards that could shake things up.
• LPL has a low market cap, but there is a reason for it looking at the income statement and the balance sheet.
• Things are looking up for LPL despite all the gloom surrounding it, but that does not mean it is in the clear.

Not much was expected from LG Display (LPL) with the company expected to announce its fourth straight quarterly loss with the Q1 2023 report. Yet LPL managed to miss estimates on the 26th by posting a bigger-than-expected operating loss. However, the market has been looking past disappointing results from LPL for a while now. The stock remains in a multi-month uptrend. It seems there are many out there banking on a second half turnaround. Why will be covered next.

LPL finishes in the red once again

LPL was expected to post an operating loss of KRW660B in Q1, but the actual operating loss turned out to be KRW1,098B as shown below, which equals $0.82B using a USD:KRW exchange rate of 1:1,338. Net loss was KRW1,153B or $0.86B. Note that there was an asset impairment charge of KRW1,330B related to the OLED business in Q4 2022, which resulted in an outsized net loss in that quarter.

Source: LG Display

Revenue fell by 40% QoQ and 32% YoY to KRW4,411B or $3.3B. This decline was driven by the same headwinds that gave LPL problems in the preceding quarters, including weak demand for display panels and excess inventories. However, there were other factors at play as well. Seasonality added to the sequential decline. More significantly, LPL's decision to downsize the LCD TV business had a major impact.

This can be seen in the table below. LPL closed the LCD TV fab in South Korea in late 2022 and the one in China is running at half capacity. This resulted in much lower production of LCD panels and, as a consequence, shipments of display panels shrank by 46% QoQ to 4.2M square meters. On the other hand, ASP rose by 20% QoQ to $850 per square meter with a lower proportion of LCD TV panels, which come with the lowest ASP.

Setbacks in the income statement naturally found their way back to the balance sheet. Cash and cash equivalents ended at KRW3,894B or $2.91B in Q1 2023, which was actually up from KRW3,547B in Q4 2022, but still below KRW4,111B in Q1 2022. Unfortunately, this was more than offset by the increase in total debt, which rose to KRW17,179B or $12.83B in Q1 2023, up from KRW14,991B in Q4 2022 and KRW13,052B in Q1 2022. Net debt-to-equity ratio is now well past 100% at 126%. It stood at 60.6% or less than half a year ago in Q1 2022.

LPL has been in the red for a while with the company posting a combined net loss of KRW4,403B or $3.29B in the last 12 months. This means LPL does not have a multiple for a number of commonly used metrics, including P/E. Nevertheless, multiples that are available are on the low side. For instance, LPL is valued at just 0.24 times TTM sales of KRW24,091B or $18B with a market cap of $4.24B. Do note that revenue will drop in the coming quarters without the LCD TV business contributing.

Source: Seeking Alpha

Why the stock has looked past recent results

The quarterly numbers have gotten worse, yet the stock has taken it all in strides. The stock fell back after the Q1 report, but LPL has still appreciated by 16% YTD, which is not bad at all considering the circumstances LPL finds itself in. The stock has actually trended higher for over six months now as shown in the chart below.

Note the lower ascending trendline connecting the lows. The stock has bounced off this trendline several times, suggesting support. The latest post-earnings drop once again challenged the trendline, but support has held, at least thus far. As long as this remains the case, the stock is bound to keep going higher.

There is a reason why the stock has held up so well despite all the gloom surrounding LPL. There are signs the display market is starting to recover, which bodes well for suppliers like LPL. For instance, prices for LCD TV panels have risen , likely with the help of reduced output from suppliers, including LPL.

While there are ways to go, industry reports suggest manufacturers are slowly ramping up their underutilized production capacity in response to improving demand. For instance, a recent report from Omdia states LCD fab utilization has reached 74% in Q2, up from 66% in Q1. OLED utilization is also getting better, although there is more to do here.

LPL itself is cautiously optimistic Q1 was the bottom to be followed by a gradual recovery starting in Q2. From the Q1 earnings call:

"Market uncertainties and volatilities still run high, and although demand is muted and inventory adjustment continues in the downstream, driven by intense cost-saving efforts, we expect Q2 profit to marginally improve versus the first quarter. As we bottom out in the first half following recovery of inventory levels and soundness, thereof, across the overall ecosystem of the industry, in the second half of the year we will see rise in demand for panels and with increase in shipment for mobile products and positive performance from the order-based businesses, we plan to achieve a turnaround in profit in the second half of the year and drive earnings improvement on a full-year basis."

A transcript of the Q1 2023 earnings call can be found here .

What could shake up the display market

The display market is showing positive signs, but that does not mean LPL is out of the woods. LPL has made the OLED business the cornerstone of its future, especially after the downsizing of the LCD TV business. LPL, for instance, is aiming to get OLED displays on a range of products like tablets and notebooks where they have been mostly absent thus far.

However, others are going for the OLED market as well. For instance, Samsung announced earlier this month that it will invest $3.1B to build an 8+G OLED fab. This one will rival LPL's own 8+G OLED fab, although it appears Samsung is targeting the IT segment with its fab. Meanwhile, competitors in China are also trying to get in on the act.

BOE, for instance, wants to increase shipments of OLED panels by 50% YoY to around 120M units in 2023. If OLED panels from other Chinese competitors like Visionox and TCL CSOT are included, then China could ship a total of around 220M units in 2023, up 40% YoY. Not wanting to be left behind, Japan Display also announced it wants to build new OLED fabs in cooperation with others. It's clear the OLED market is set to become a lot more crowded in terms of the competition.

The U.S. government could be the wildcard

There have been rumors the U.S. government is considering imposing trade restrictions on China regarding OLED technology. Note that this is not the first time this issue has come up. There was similar talk several years ago, but nothing came of it back then. Nothing has been agreed to, but it's possible the U.S. government could change its mind and decide to impose export controls on OLED technology.

On paper, restricting Chinese suppliers of OLED panels could benefit non-Chinese suppliers like LPL who could stand to gain business. On the other hand, LPL's most advanced OLED fab is located in China. If there are indeed sanctions on China and depending on the fine print, there could be far-reaching consequences for LPL and the display industry as a whole.

Investor takeaways

There are a number of reasons why some may be pondering about shorting LPL. For instance, the balance sheet is getting worse with LPL deep in the red. Indeed, most on the street rate LPL a sell. Nevertheless, I remain neutral on LPL as stated in a previous article . It's true LPL is still in the midst of a deep slump with an imbalance between supply and demand in the display market.

However, this market is showing signs of improving as panel manufacturers, including LPL, have reduced their output of display panels, LCD and OLED. The market has taken note of these efforts and the stock has been rewarded with a substantial gain in 2023, despite all the horrible numbers in recent quarters, including in the most recent Q1 report.

Still, it's too early to conclude LPL is in the clear. LPL has made OLED the centerpiece of its turnaround strategy, but all the aggressive moves by competitors to increase their OLED footprint is reason for concern. In addition, there are a number of wildcards out there that could alter the road ahead for the display industry.

There has been renewed talk of possible trade restrictions in the OLED market. In theory, LPL stand to be impacted greatly if that were to happen, but it's unclear whether it will be a net positive or a net negative for LPL. It's also unclear what kind of impact advanced forms of LCD technology, like miniLED and microLED, will have on the OLED market. MicroLED, in particular, has a number of key advantages over OLED displays, although it is not clear when the technology will enter the market in a big way.

Bottom line, LPL could continue to trend higher as long as recent improvements in the display market continue. While the income statement and balance sheet are nothing to write home about, both can improve as long as the display market gets better. LPL only has a market cap of about $4B, which suggests most, if not all, the bad news is priced into the stock. There is after all a reason why there is very little short interest in LPL despite all its current problems.

With that said, LPL could easily give back all the gains from the last six months or so if conditions in the display market regress. This could happen if some or all panel manufacturers decide to take their foot off the brakes and start pumping out panels with no regard as to whether there is enough demand out there to absorb all the output. If that happens, expect the stock to drop as quickly as it rose.

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