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LG.Philips: This Side Up

Every so often, I call one right. In marked contrast to my horribly bad call on the aborted Lockheed (NYSE: LMT  ) /Titan (NYSE: TTN  ) merger, it appears that this Fool called the LCD TV glut correctly, at least in the short term. For proof, you need look no further than yesterday's LG.Philips (NYSE: LPL  ) earnings release.

The joint venture between Korea's LG Electronics and the Netherlands' Philips (NYSE: PHG  ) reported an increase in year-on-year sales for its fiscal third quarter (up 12%). However, sequential sales were down 20% versus Q2. More important, profits took a dive both year-on-year and sequentially, with operating income down 30% in comparison to Q3 2003, and an incredible 67% when compared to Q2 2004.

The reason was crystal clear. A ramp-up in worldwide supplies of LCDs, combined with depressed demand (caused by the products' high prices), resulted in a spate of price-cutting. LCD prices in Q3 dropped about 20% since the previous quarter.

But that wasn't all the bad news in store for LG.Philips investors: Stabilization between supply and demand, earlier predicted to come together in Q4, has been delayed. Oversupply is continuing to depress prices, and LG.Philips is expecting its prices to fall by as much as another 30% through the first six months of 2005. Combined, that adds up to a collapse in LCD prices of epic proportions -- nearly 50% in the space of a single year.

So what's an investor to do? With prices in freefall and the company racking up less profit the more it sells, does this mean that LG.Philips, barely one quarter into its life as a publicly traded entity, is already doomed?

Far from it. If I may wax contrarian once more, I think the collapse in LCD prices will be a good thing for LG.Philips. It's simple economics: lower prices mean greater demand. Continued pricing weakness in the first half of 2005 should attract more and more buyers to the company's products. And LG.Philips is already boosting capacity to meet that demand. If this investment thesis plays out, then by the second half of 2005, LG.Philips could well be sitting in an economic sweet spot. Both production capacity and demand will rise in tandem as new factories come on line to satisfy consumers' lust for TVs you can hang next to the family photos. Come June-ish 2005, I suspect that we will see not only LG.Philips, but competitors such as Sony (NYSE: SNE  ) and Toshiba, rolling in money. Similarly, shareholders of LCD TV retailers such as Gateway (NYSE: GTW  ) and Best Buy (NYSE: BBY  ) should be smiling next summer as well.

Want to learn more about the investment potential of the LCD producers? Read:

Fool contributorRich Smithowns no shares in any company mentioned in this article.

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