Summary
- Himax Technologies has been struggling with serious margin contraction amid inventory headwinds.
- Margin pressure is expected to last for several quarters as the company tries to lower inventories to historical averages.
- Luckily, the company expects to fully resolve these issues by Q3 2023, which makes HIMX stock a good Hold candidate.
The recent big move by Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) whereby the company sold 86% of its stake in Taiwan Semiconductor Manufacturing Co (NYSE: TSM ) worth more than $4 billion drew my attention to TSMC’s Taiwan-based peer, Himax Technologies Inc. ( HIMX ). The two companies are only related tangentially: TSMC is the world’s largest contract chip maker accounting for more than half of global foundry revenue whereas Himax is a fabless manufacturer of display driver integrated circuits and timing controllers used in TVs, laptops, tablets, mobile phones, monitors, digital cameras, car navigation and VR devices with a much smaller revenue base. However, the two companies face the same geopolitical risk of China attacking/invading Taiwan. This risk has been present for many years but has become even more prominent following Russia’s invasion of Ukraine, which could be one of the reasons why Buffett unloaded such a large stake in TSMC.
But first a quick look at how these stocks have performed so far this year.
After a deep dive in 2022 due to a confluence of factors, including geopolitical unrest, increasing inflation, supply chain disruption, soaring cost pressure from interest rate hikes and lingering effects of the pandemic, the U.S. semiconductor sector has been on the mend this year as evidenced by the 18.7% YTD gain by the sector’s favorite benchmark, iShares Semiconductor ETF ( SOXX ). HIMX stock has gained 24.1% while TSM is up 19.3% despite the latest selloff triggered by Buffett’s big sale. This year we are actually witnessing a reversal in fortunes with cyclical sectors such as the erstwhile high-flying energy sector turning into a major laggard while growth stocks, semiconductor and tech stocks.
Although the issues that plagued the semiconductor sector last year have not been fully resolved, this year’s outlook is brighter:
The global semiconductor market experienced significant ups and downs in 2022, with record-high sales early in the year followed by a cyclical downturn taking hold later in the year. Despite short-term fluctuations in sales due to market cyclicality and macroeconomic conditions, the long-term outlook for the semiconductor market remains incredibly strong, due to the ever-increasing role of chips in making the world smarter, more efficient, and better connected,” John Neuffer, president and CEO of the Semiconductor Industry Association,'' has said .
Whereas the rising tide appears to be lifting all (or at least many) boats, I think HIMX may have limited upside at this juncture due to serious inventory and margin issues as we shall see shortly.
Margin Contraction and Inventory Headwinds
Himax reported Q4 2022 and full-year results on February 9th. Q4 revenue of $262.2M was in-line with the Wall Street consensus, good for a healthy sequential increase of 22.8% but a huge 42.0% Y/Y contraction while Q4 Non-GAAP EPS of $0.27 was also in-line with the consensus. Full-year revenue clocked in at $1.20B, good for a 22.6% contraction; operating income fell 52.7% to $257.6M while full year net income of $276.1M represented a 40.4% decrease from the previous year.
But more concerning has been the company’s margin trends. Himax reported that fourth quarter IFRS and non-IFRS gross margin both clocked in at 30.5%, a significant sequential decrease from 36.0% and 36.3%, respectively, but a huge drop compared to 51.8% for Q4 2021; operating margin. Full year gross margin clocked in at 40.6% compared to 48.5% in 2021; operating margin fell from 37.4% to 25.5% while net margin came in at 23.0% compared to 30.0% in 2021.
You will notice that these are not the usually tolerable margin contractions of a few single-digit or even double-digit basis points but huge decreases that sometimes exceed 10-percentage points. According to the company, price erosion from offloading excess inventory has been the predominant factor that has been adversely impacting its margin profile. The company has also blamed the margin contraction on higher cost of inventories sourced primarily during 2021 and early 2022 when capacity constraints led to higher foundry and back-end pricing. Further, Himax says that the disruption in consumer demand due to Covid-related lockdowns as well as significantly reduced visibility at panel houses and OEMs negatively impacted IC demand and sales with the abrupt drop in demand resulting in a rapid increase in inventory levels.
Looking ahead, Himax provided weak guidance that proves that its inventory issues might take several months at the very least to fully resolve. The company expects Q1 2023 revenues to decrease 12.0% to 17.0% QoQ while IFRS GM is expected to deteriorate further to 28.0% to 30.0%. Himax says that another contributing factor to Q1 margin contraction are write-downs necessitated by certain unsold inventories.
The Bright Side
Thankfully, Himax says that these effects will gradually diminish throughout the year and expects its inventory levels to return to historical averages not later Q3 2023. Investors looking to initiate or build positions should keep a keen eye on the company’s margin trends as the quarters roll on.
During its earnings call, Himax announced that it managed to add several new sales streams to its product mix in 2022, including the ultralow power WiseEye smart sensing and ICs for AMOLED. The company has reported that both product lines enjoyed good uptake and higher than corporate average gross margins, so that should also help with the company’s bottom-line headwinds. Meanwhile, Himax’s pivotal automotive segment has been outstanding. In 2022, automotive sales increased more than 50%, extending a string run when they grew more than 110% in 2021. The company expects these encouraging trends to continue in 2023.
Himax has a $9.67 consensus price target , implying 23.5% upside, which I think is a fair valuation. I rate HIMX stock a Hold, but could present even higher upside if it manages to solve its inventory and margin issues in the coming months and quarters.
For further details see:
Himax Technologies: Margin Pressure Persists Amid Inventory Headwinds