Published:
September
29, 2008
Liquid crystal display (LCD) screens
have replaced bulky cathode ray tube
(CRT) technology as the desktop
computer monitor of choice for most
consumers; meanwhile, almost all
laptops use LCD technology. In
addition, LCD televisions are far
sleeker than older technologies and
offer better picture quality than
plasma models and have become
extraordinarily popular and
profitable in recent years. And
AU Optronics Corporation (NYSE: AUO,
$11.70) is one the world's
largest manufacturers of liquid
crystal displays.
Like all electronic products,
average selling prices for LCDs have
declined over time. This might seem
like terrible news for AUO as
falling prices spells declining
revenues. However, that's not
necessarily the case here. When the
first LCD monitors hit the market
more than a decade ago, average
selling prices were sky-high,
putting the new technology out of
reach of all but the wealthiest
consumers. But that has changed --
LCD panels are now available for
just a few hundred dollars and most
new computers come standard with an
LCD monitor. Falling prices in
effect stimulated demand, creating a
larger market for LCD screens.
The same thing has happened with
TVs. The first LCD displays were
relatively small and carried high
price tags -- over time prices have
gradually fallen even as the
technology has steadily improved.
This too has prompted most U.S.
consumers to make the switch from
old-style CRT TVs to LCDs. Consider
that in 2003, 88% of U.S. TV
shipments were still CRTs, and it
wasn't until 2006 that the CRT share
of new TV sales dropped under 50%
for the first time. But by 2010 LCD
sales are expected to approach 90%
market share -- the entire market is
shifting in just a seven-year
period.
The same basic trends are underway
outside the U.S. Legions of
consumers in emerging markets with
rising disposable incomes are buying
their first TV sets -- falling LCD
prices will create demand in these
markets as well.
And companies like AUO aren't hurt
as badly by falling selling prices
as you might think. As sales volumes
ramp up, AUO and other firms in the
business find ways of cutting
manufacturing costs and improving
efficiencies. Thus, their
manufacturing costs fall alongside
prices, helping to preserve profit
margins. AU Optronics has seen its
margins increase from 5% in 2006 to
above 18% today.
There are several big players in the
LCD manufacturing business,
including Japanese giants like Sony
(NYSE: SNE) and Panasonic, as well
as Korea's Samsung -- this is a
highly competitive market. That
said, AU Optronics is one of the
best placed firms in the business.
However, with an estimated global
market share of 20%, AUO has the
scale to invest in modern,
large-scale, lower-cost LCD plants.
Thus, the firm enjoys a cost
advantage over smaller rivals.
Recently, the company has opened
several manufacturing facilities in
the low-cost Chinese market; easing
cross-strait relations should make
further such foreign direct
investment easier.
Finally, AU Optronics is well
exposed in the most profitable large
LCD market. The largest panels are
the most complex to manufacture, but
also offer the highest selling
prices and the best margins for
manufacturers; AUO has one of the
largest line-ups of these most
profitable displays.
There are some near-term headwinds
facing the LCD market. Specifically,
a slowdown in the U.S. and other
developed market economies is
crimping demand. In addition, some
retailers have built up inventories
of LCDs to higher-than-average
levels; if sales don't materialize,
these retailers will cut back on new
orders as they work down
inventories.
Nonetheless, long-term demand for
the technology looks solid. The LCD
market will continue to grow faster
than the television market as a
whole in the developed world;
consumers will continue to make the
switch from CRTs. And in the
developing world, fast growth in
demand for consumer electronics
should lift sales of LCDs. As
consumers become wealthier, sales of
higher-end and higher-margin LCDs
should also continue to expand.
Action to Take --> AUO currently
trades at just 4.3 times 2008
earnings estimates and has a
long-term projected growth rate of
+10%. Trading at just 40% of its
expected growth, investors are
already fully pricing in near-term
market headwinds. With AUO trading
at its most depressed valuation in
years, the current price offers an
outstanding buying opportunity for
more aggressive investors with the
stomach for near-term volatility.
Paul Tracy
Editor
StreetAuthority
Market Advisor
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Paul Tracy co-founded StreetAuthority.com and became the firm's
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Paul's previous experience includes a position at Robert W. Baird & Co.'s
full-service brokerage operations as well as economic research work on a Money
and Banking project funded by the National Bureau of Economic Research. He has
also spent time doing outside consulting and research for the University of
Virginia, has appeared as a guest expert on several prominent financial radio
shows, and has been a featured speaker at various investment conferences across
the U.S.
Paul graduated with a B.S. in Finance and Management from the McIntire School
of Commerce at the University of Virginia.
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