LCD: Valuations supportive, not getting worse ::Macquarie Research,

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LCD: Valuations supportive, not
getting worse
Event
 We provide an update on the LCD sector and the roadmap for 2H11.
Fundamentally, there is no strong sign of demand recovery in 2H but supply
side is being controlled as pricing is close to cash cost levels. Stock-wise,
similar to other cyclical subsectors like DRAM, memory and LED, LCD
earnings revisions are negative but LCD names (AUO/LGD) is one of few
subsectors where valuations are trading at, or below, 2H08 crisis levels and
so further downside potential is limited, in our view. We are OP on AUO/LGD
on their low valuations and we like Radiant/TSMT in the supply chain, but
remain UP on Coretronic/NEG.
Impact
 Panel ASPs falling but close to cash cost. 2H Sept panel ASPs fell 1-2%
(reported Wednesday morning by Displaysearch) and this will likely hurt panel
makers’ 3Q profitability (as the 3Q decline is more than guided for). However,
the pace of decline is slowing as we are 5% or less away from cash costs;
most panel makers will start to lower UT rather than drop prices further. There
is some downside to LCD panel makers’ 3Q/ 2H11 forecasts; we think the
market is aware of this.
 Supply side being controlled. On the supply side, in light of the soft demand
and macro, industry has started to control supply by reducing UT and capex
spend. TV brands are reluctant to build for the holiday season despite healthy
channel inventory, so panel makers will lower UT in 2H and are aggressively
cutting 2011 and 2012 capex, which will help to limit supply growth in 2012.
 No strong signs of demand in the West. In EU/US, TV brands are cautious
on 4Q demand due to the macro situation and thus orders remain muted as
no brand is trying to build aggressively. There will be some promotions for
Black Friday (Samsung more aggressive, Sony and LGE more muted) but it is
not as strong as previous years; sell-through expectation for holidays are low.
 China slightly better. China has seen some pre-build for Golden Week but
aggressiveness and inventory levels are much lower than prior years (8-9
weeks this year vs 10-12 weeks in past years). Thus post-Oct 1 sell-through
will be a near-term gauge as expectations are low (AVC expects ~10% YoY
growth) and given mild pre-GW build up, if sell-through is OK, we could see
some re-stock from China ahead of the earlier CNY 2012 in late 4Q11.
 ERC near a bottom. Similar to other cyclical sectors like DRAM and LED,
LCD earnings revision (ERC) has reversed and gone negative, implying the
street is currently very cautious in its forecasts. While ERC is not a complete
gauge, interestingly LCD names (such as AUO at 0.5x PBV or LGD at 0.6x
PBV) is actually one of the few tech subsectors where valuations are at or
below levels seen in 2H08 GFC, so further price downside is limited in our
view (by contrast, Epistar trades at 1.1x PBV vs 0.5x PBV in GFC).
 AUO still cheap even in bear case. There is downside to our 2H11 forecast
but even if we assume AUO posts losses in 2H11 at 1Q11 level (i.e. NT$14bn
net loss per qtr) and remains loss-making throughout 2012, that would put
AUO's BVPS at NT$22.7 at year-end 2012 (NT$32 year-end 2010), or PBV of
0.5x 2011 and 0.56x 2012 PBV (still lower than GFC levels). We have OP on
AUO and LGD due to valuations and Radiant/TSMT in supply chain due to
leverage to Apple. We are negative on Coretronic/NEG due to softer demand
and company-specific issues. Any fundamental re-stock or better macro
outlook in 1H12 would mean cyclical subsectors like LCD could be the beta
plays to watch in our view.