Thursday, September 09, 2010

AU Optronics (NYSE:AUO): Upgrade to Buy from Neutral - Inflection point near - UBS

UBS Global I/O team is upgrading the TFT-LCD space to Overweight while downgrading LEDs and Memory to Neutral & Underweight, respectively.

More specifically in the TFT-LCD space UBS is upgrading LG Display (NYSE:LPL) to Buy from Neutral/Short-Term Sell and AU Optronics (NYSE:AUO) to Buy from Neutral.

Firm's LCD team thinks stocks become attractive as an inflection point in panel prices is within sight, and they see incremental pricing downside of ~6-13% from 1H-Sep to get to price points that can support holiday sales. They expect 3Q oversupply to ease in 4Q given utilization cuts & better demand due to price elasticity.

They are cautious on tech demand but they upgrade AUO because LCD stocks tend to move 1~2 quarters ahead of fundamentals. They think that investors need to look past weak earnings for 3Q/4Q10. After 27% drop YTD, they think AUO factor in a downturn at 0.8x P/BV (near historical trough) hence, look attractive as they feel we are nearing the inflection point. In past three upturns, AUO’s share price has generated 33% on average from the inflection point in panel prices.

Good returns on reaching inflection point in panel prices
In the past cycles, UBS noticed that an inflection point in terms of panel price was a big share price driver. During the past 3 upturns which lasted for 7 months on average, AUO’s share price generated return of 33% on average.

We have seen panel price drop 21~32% for IT panels and 16% for TV panels from peak in March. Important question is whether we have found the bottom in panel prices.

Calculating the bottom panel price
There is no magic formula to calculate bottom panel price. UBS notes they can come up with a reasonable forecast if they assume that both panel makers and set makers equally share the burden in supporting decline in retail prices. Given that panel makers are cutting utilization rates to stabilize panel prices, they think this assumption would be a bit aggressive for panel makers. Nonetheless, this would give a conservative estimate of a bottom price.

UBS takes 32” LCD TV (low-end) and top 4 brands in the US to demonstrate their point. June/Sept retail and panel prices are actual figures. If they assume retail prices in Dec, 2010 will fall to $299 (Vizio), $329 (LG, Sony) and $349 (Samsung) based on their checks, this would imply 19~25% cuts at retail from June to Dec 2010. If panel prices have to fall by the same magnitude, Dec panel price would have to reach $152~164 which would be $10~22 off from 1H-Sept price of $174 or 6~13% cuts. This implies that we are a couple of $5~10 cuts away from finding a comfortable bottom.

AUO cutting utilization by 10~15% in 3Q10
To combat falling panel prices, UBS believes that AUO has lowered utilization rates by 10~15% from mid-3Q10. While this is more than 5~10% cut by Korean peers, AUO is faring better than CMI and Sharp who they think cut 15~20%, in their view. Moreover, AUO has kept pace with Korean vendors in LED TV mix as well as on vertical integration efforts which UBS thinks will pay off when the sector recovers.

Notablecalls: OK, first of all this call is NOT coming from Stephen Chin, the UBS analyst many consider the Axe in the LEDs space (CREE, VECO etc).

With this out of the way, the call still looks interesting. I would not be surprised to see AUO and LPL move higher today.

I see little impact on CREE & VECO.

No comments: