LG Display 3Q19 Earnings and Industry Implications
LG Display reported revenue of KRW 5.8 trillion with a negative operating margin of -8%. Revenue was up 9% from the prior quarter, but down 5% from the 3Q18. Area shipments were lower as LGD reduced capacity likely to reduce sales of unprofitable LCD TVs. EBITDA was up 34% quarter-over-quarter (down 40% from the prior year) as the ASP was up 13% QoQ.
The favorable quarterly revenue growth and EBITDA margin was primarily due to increase shipments of mobile plastic OLED which carry a higher ASP. The below chart details that on a year-over-year (“YoY”) basis the company financials deteriorated significantly.
LG Display Capacity and Utilization
LGD reduced its fab utilization to adjust for the increasing supply of Chinese 10.5 Gen production. We calculate that LGD’s actual utilization is less than 73%. LGD will start to downsize fab capacity at its P7 and P8 fabs. If they did not, we estimate the in 4Q19 the utilization would be as low as 67%.
While gross and operating margins were inline with our expectations, there were interesting changes in specific components. Specifically, BLU (backlight unit) consumption decreased and glass cost per unit materially increased. We attribute this to increased mobile OLED mix (no BLU) and the ramp at the E6 fab and the Guangzhou Oxide OLED fab.
- BLU costs on a per unit decreased materially. EGI (Electrolytic Galvanized Iron) is the main raw material for BLU components. EGI average price decreased by 9.2% from 2018 to the third quarter of 2019. The 2019 third quarter decrease was due to the concerns of a slowdown in the global economy and an increase in inventory levels.
- Glass cost spiked almost 2x on a per unit basis. We are researching if this was due to increased use of Corning’s Astra for mobile encapsulation, Astra for Oxide backplane, R&D costs, buy-ahead, or some other lever.
Capacity and Substrate Strategy
LGD was vague on the long term strategy because the CEO, Jeong Ho-young, is new. There are a lot of moving pieces in the industry and LGD is continuing to shift its business to OLED (e.g. reducing the supply at P7 and P8). The LCD capacity reduction and increase in OLED production will help reduce the ASP pressure and offset the continue LCD price declines. As we detailed in Q2, LGD had to do more than reduce its labor force to offset the margin pressure. Continued conversion to OLED, idling lines, and labor reductions are all necessary.
LG Display and Samsung are fortunate to be vertically integrated. We think the industry will evolve over the next decade to be similar to other consumer industries by having more product variety. We have seen similar things in the consumer electronics and consumer good industries. As examples:
- iPhone 8, iPhone 8 Plus, iPhone X
- Standard beer, premium beer, micro-beer
Samsung and LGD can use LCD as the standard and premium, and OLED as the ultra-premium. They can earn large margins on the OLED and harvest the LCD investments for lower margins. Because of this we expect an increase in selling and marketing costs in 2020 and beyond for both LGD and SDC in our modeled financials.
Companies like AUO and Japan Display will continue to face business risk and financial risk.
Our industry modeling analyzes supplier underutilization and therefore LGD should be contemplating completely shutting down P7 or P8, and converting to OLED. Mostly likely LGD is messaging to SDC to also reduce LCD capacity to help firm-up pricing. Given demand continues to drop and industry panel supply has increased 35% between 2016 to 2020, it is unlikely that a single fab shutdown would be meaningful to total pricing. One potential implication is that weaker capitalized players will be forced to completely shutdown fabs.
LG Display Forecast
We are estimating LGD incurs an loss of ~340 billion Won in Q4 net income. As previously detailed, LGD has to suspended production at various fabs. It comes down to free cash flow and if LGD thinks industry pricing will be impacted by a single fab shutdown.
While there are challenges, this is an optimal time to be a customer of the panel suppliers. Our should-cost model has been updated based on suppliers' Q3 costs. It details the cost of various OLED and LCD panel sizes based on the individual panel's input materials, overheads, yields, and profit margin. Component pricing should be aggressively negotiated. We recommend using our should-cost model and industry capacity analytics to understand suppliers’ actual cost structure.