RealMoney Silver - AU Optronics Could Soon Display Solid Performance

AU Optronics Could Soon Display Solid Performance
By Bill Trent
RealMoney.com Contributor
6/16/2008 10:31 AM EDT

In a normal economy, shares of Au Optronics (AUO) would be rising as fast as the company's sales. Instead, sales and cash flow are zooming, and the company has been topping estimates by a wide margin, but shares keep moving sideways and now trade for less than 5 times projected EPS. In time, look for shares to catch up with the growth metrics.

AU Optronics makes thin film transistor liquid crystal display (TFT-LCD) panels and other flat-panel displays, which are used in notebook computers and desktop monitors, as well as in portable consumer electronics devices and LCD televisions. AUO competes primarily with LG Display (LPL) and Samsung Electronics, both of which are larger than AU. Corning (GLW) is also a significant force and is one of the company's primary suppliers for glass substrates.

Discipline Should Pay Off

I have been skeptical about the flat-panel manufacturers for the past couple of years. As frequently happens with hot technology, growth seems to have gone to the heads of management teams, who ended up building more capacity than was needed.

According to a recent Wall Street Journal article, some Asian liquid-crystal display manufacturers are moving toward making small panels for computers, as an inventory buildup pushes prices lower for television panels. Analysts say more LCD makers might follow suit amid weak TV-panel prices, and that the shift could stem the price increases that have been seen for notebook-PC and computer panels in the past few months.

However, I began to notice last year that the capacity additions were being pulled back to more realistic levels. AU plans to spend $3.3 billion for each of the next two years in capital expenditures, which is roughly in between spending levels of 2007 and 2008. The budget is also flexible enough to expand or contract in line with unexpected changes in demand.

Though these things always take time, the constraint boded well for the future outlook. As I said at the time, as demand caught back up to the added supply, the long lead times for adding capacity could make for a very profitable 2008.

The company's most recent annual report shows that the company's growth rates may be even better than I anticipated. AU Optronics said recently that robust demand for computers and LCD TVs is likely to cause a tight supply of panels soon, and new PC models will further drive growth into next year. Even in a slowing U.S. economy, research firm DisplaySearch believes emerging-market demand for laptop PCs will be strong in the next two years.

To be sure, the flat-panel business remains quite cyclical. Moreover, as an ADR, the share price will thus be affected not just by company fundamentals, but also by the exchange rate between the U.S. dollar and the Taiwanese dollar.

In addition, company Chairman Kuen-Yao Lee's Lee, who is also chairman of Qisda (formerly BenQ), was indicted by the Taoyuan District Prosecutors' Office on charges of insider trading of Qisda stock and other related charges. While AU is not a party to these proceedings, a judgment against Lee that forces his resignation, or even simply adverse publicity surrounding the case, could have an adverse impact on the company's shares.

Ridiculously Cheap?

Zacks Investment Research notes that shares are currently selling for 5.8 times current-year EPS estimates of $3.38 a share. Estimates have risen nearly 20 cents in the past month, and two of the five covering analysts have raised their numbers.

The company generated $4.8 billion in cash flow from operating activities in 2007 and used just $2 billion for capital expenditures. The resulting $2.8 billion in free cash flow represents a 17.7% free cash flow yield based on the current $15.84 billion enterprise value. Even if the free cash is cut in half (capital expenditures are expected to be twice as high this year) the yield would be more than double the current yield on five-year Treasury bills. That's a pretty healthy premium for a company expected to grow 30% annually over the next three to five years.

Finally, AU Optronics is also trading at a mere 1.32 times book value, below the industry average of 1.62 times. Even if the company only grows in line with its 14% return on equity, an expansion to the industry average valuation could provide 20% annual total returns over the next five years.

When the market kicks into gear, AUO could be poised to move up nicely.