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2019-10-16 20:41:29

The CEO of LG Display (LPL) announced in September that he is to step down. A new CEO is to be formally named in March of 2020. The resignation comes on the heels of LG's struggles with losses due to falling prices for LCD panels. In Q2, the company suffered a net loss of 550B South Korean Won or roughly $460M at current exchange rates, an increase of 83% YoY.

The market for thin-film transistor liquid crystal display (TFT-LCD) panels remained under pressure in Q3, which makes it highly likely that LG will report more losses when they release their next earnings report. However, there is reason to think that LG will be better off in the coming months. That should lift the stock, if only temporarily. There are a number of factors why that is so.

Unit: billion South Korean won

Q2 2018

Q2 2019

Revenue

5611

5353

Net income (loss)

(301)

(550)

Source: LG Display

Problems in the LCD market and responses by companies

Average prices for LCD panels have been falling for months, including all throughout Q3. The root problem is excess supply of LCD panels, especially from manufacturers of LCD panels in China. Demand has not been able to keep up and absorb all the new supply entering the market. The result has been decreasing prices for LCD panels.

Different companies have come up with different responses to deal with the problem. For example, the approach taken by Chinese manufacturers is to make further improvements to LCD technology. The hope is that this will entice consumers to go out and buy new LCD panels with additional features that previous generations of LCD panels did not support.

This has resulted in new products such as dual-cell or dual-layer LCD panels. Dual-cell panels consist of two LCD panels stacked on top of each other and then bonded together. By doing so, they are much better at displaying the color black, which in turn allows for much higher contrast ratios compared to traditional LCDs. China's Hisense claims that the dual-cell LCD panels offer much improved picture quality to the point that they begin to rival that found in organic light-emitting diode (OLED) displays.

Samsung, the leader in the display market, is also looking to upgrade its display panels. Samsung is turning to Quantum Dot (QD) displays and intends to incorporate the technology in all the panels it produces. QD panels are said to be capable of reproducing color that is extremely close to the real thing, much closer than current technology is capable of. The company may invest as much as $11B in QD technology.

LG went in another direction. Its solution is to avoid stiff competition in the LCD market and instead focus on the OLED market, especially big-screen OLED TVs. OLED panels are superior to LCDs in terms of picture quality and LG is banking on this to give it an edge in the display market.

As part of this effort, LG launched volume production of a new Gen-8.5 fab in August that is dedicated to producing OLED panels for big-screen TVs. LG's OLED production capacity has almost doubled to 130,000 sheets per month with this second plant. In addition, LG is cutting costs. For example, a number of employees will be offered early retirement.

LCD prices should get a lift from seasonal demand

However, despite all these attempts, the LCD market has yet to stabilize. If the market is to see some sort of recovery in the near future, no matter how small, other factors will need to come into play. The good news is that one such factor is almost here. The market is approaching the end of the year, which means that the holiday season will soon be upon us.

There is not only Thanksgiving and Christmas in the U.S. In China, there's also Singles Day and the Lunar New Year. With so many holidays around the corner, shopping is sure to give sales a boost. This should help increase demand for LCD panels as TVs are more often than not on people's wish list. Increased demand should help support LCD prices, if only for as long as the holidays are with us.

Manufacturers may have no choice but to cut output

While seasonal demand may help give prices a lift, they're unlikely to last beyond the short term. Specifically, the excess supply of LCD panels flooding the market will need to be addressed at some point. It's hard to see how the market can remain stable if supply is not brought under control.

The encouraging sign is that a number of manufacturers have signaled their willingness to reduce output of LCD panels. Prices in several categories of LCD panels have already fallen below cash costs, at which point it no longer makes sense to produce such panels. Manufacturers in China, South Korea and Taiwan have all started to or intend to lower their utilization rate in an effort to balance supply and demand.

According to data from TrendForce, South Korean companies like Samsung and LG Display have been the most aggressive in lowering output. For example, Samsung is lowering utilization rates at its Gen-8.5 fabs by 30 to 40% and at its Gen-7 fabs by more than 50%. LG is also lowering capacity at its fabs. Capacity at its Gen-8.5 P8 fab will be reduced by 75% and its Gen-7.5 P7 fab will be reduce by two-thirds. Taiwan's AUO is doing its part by reducing output at its Gen-8.5 8A fab by 50% and at its Gen-6 6B fab by 20%.

The big wildcard are the intentions of Chinese manufacturers of LCD panels. There have been doubts as to what they would do, but it now appears that they too will cut output. If only at a lower rate than other manufacturers. CSOT will decrease output at its Gen-8.5 T2 fab by 20%. BOE will reduce output at its Gen-10.5 fab by 20% and CEC-CHOT will also cut output at its Gen-8.5 fab by 20%. In addition, a new Gen-10.5 fab from Sharp, scheduled to start production, has postponed doing so for the time being.

Source: Wikimedia Commons

Investor takeaways

Q3 has already concluded and at this point it is almost certain that LG will report another loss for Q3 if we take into account recent LCD prices. However, Q3 may turn out to be the quarter LG hit bottom. There are several reasons to think that the next two quarters will be better for LG than the ones before.

Assuming that manufacturers don't change their mind and stick to reducing output as planned, supplies of LCD panels could be drastically reduced in the coming months. This is the most important factor that will determine where prices go in the short term. If supply can be brought under control, then prices should start to recover. But failure to take action could send prices into another free fall.

Demand should also get a lift in the coming months from the start of the holiday shopping season. Display technology continues to improve thanks to technological innovation. It's quite possible that new LCD panels offering improved features can help sway consumers towards upgrading their older displays.

Assuming that shoppers don't pull back on spending, the combination of increased demand and reduced supply should go a long way towards bringing some balance back into the market for LCD panels. It may not last indefinitely, but the next one or two quarters should see improved market conditions. And possibly even longer if manufacturers can remain disciplined in terms of output. All that should help LG.

Stable or perhaps even higher prices for LCD panels will help boost LG's stock, even if the company suffers another loss in Q3. The fact that the market for LCD panels seems to be improving will be given greater weight than earnings as the former is more forward looking than the latter. As long as substantial progress is made toward balancing supply and demand, LG's stock can appreciate even if the company is still running at a loss.

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.


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