Despite mounting macroeconomic negativity working against positive progress, OLED display patent holder and raw material seller Universal Display (NASDAQ:OLED) had a solid showing in the first quarter of 2020. For now, manufacturing supply chains remain in good order and new screens are still being built, leading to another double-digit, year-over-year period of revenue and profit growth. However, question marks abound because of the coronavirus and the economic lockdowns around the globe put in place to try and halt the spread. Universal Display didn't provide any full-year guidance as a result.
Because of this near-term uncertainty, shares of the manufacturing supplier are down some 30% this year from all-time highs (and were down about 50% during the worst of the market meltdown in March). Some near-term breakdown in financial upside has thus been priced in. For longtime owners of the stock, though, this is territory revisited and is par for the course for a cyclical manufacturing-dependent business model. Based on the eventual potential for the OLED market, Universal Display is now a growth-at-a-relative-value play.
New story, similar results
First, the Q1 headline figure: Revenue increased 28% year over year to $112.3 million. An advance order placed by a Chinese customer at the end of 2019 due to trade war concerns accounted for $24 million, and another $20 million was due to advance orders from some customers concerned over potential supply-chain issues later on down the road.
Some other Q1 highlights: Of the total, $60.6 million in revenue came from the sale of raw materials used in the manufacture of OLED screens (up 9.5% year over year) and the balance was mostly from royalty fees on Universal Display's patented manufacturing processes (up 42%). Gross profit margin took a hit due to variability in product mix and came in at 80% (82% a year ago). Paired with a higher tax bill, net income increased at a 21% rate -- slower than top-line growth but nonetheless a respectable figure -- to $38.2 million. All told, it was good for a net profit margin of 34%.
While guidance for the balance of 2020 was withdrawn, customers pulling forward ordering of raw materials could be a good omen of higher demand for OLED screens. While the global economic crisis is wreaking havoc on sales for many industries (travel, restaurants, entertainment), the digital realm is holding up well. The trend is being driven by shelter-in-place and work-from-home orders. While supporting software services are getting the biggest boost, higher usage of devices and increased time at home spent with them could potentially lead to new purchases of TVs, monitors, phones, and the like -- an increasing number of which feature an ultra-high-definition OLED display.
A volatile ride to long-term upside
Of course, it remains to be seen whether OLED device sales get a bump or not, and the cloudy outlook has been somewhat accounted for with the recent fall in share price. However, Universal Display management reiterated that the long-term view for business remains intact.
Specifically, near the end of 2019, CEO Steve Abramson reported that the company's previous prediction for manufacturing capacity to increase 50% from 2017 to 2019 had in fact come true. Compounding that growth was a renewed call for another 50% increase in capacity from the end of 2019 to the end of 2021. Given OLED is still a tiny, low, single-digit percentage of the whole digital display pie, the rapid rise of the higher-definition and less power-hungry display type doesn't seem totally out of line -- especially as costs to produce OLED screens continue to fall.
The forecast is being borne out already. OLED screens have been a staple of high-end smartphones for years now, but the myriad more mid- and low-end smartphones are now starting to get the tech as well. Same goes for big screen TVs. A few years ago, it was just a couple of manufacturers that offered ultra-high-def OLED screens. The count is up to 15, with another four boarding the bandwagon later this year. Wuhan China Star (a subsidiary of TV maker TCL) signed a contract to open its second OLED factory, planned to be even bigger than the first. And then there's the small but growing market for OLED lighting, including for the automotive industry, which is only just beginning to scratch the surface of the legacy LED-dominated market.
Suffice to say Universal Display has numerous growth levers to pull. Headwinds or not, the long-term thesis for owning the stock remains, and this recent pullback in share price will likely play out like the one in early 2018 (after a big ramp-up in new production took a breather) and the more mild one in the autumn of 2019 (due to trade war uncertainty). Such is the roller coaster ride that manufacturing investment entails.
Granted, Universal Display stock does currently trade for 49 times trailing 12-month free cash flow (revenue less cash operating and capital expenses). That's a hefty premium. However, bear in mind that basic profitability will likely race higher in the next two years if Universal Display's predictions on OLED uptake hold true again. Free cash flow has surged nearly 70% higher over the last trailing three-year stretch.
Plus, there is a lot of value in having ample liquidity on hand when the world is undergoing extreme stress. Universal Display finished March with $640 million in cash and short-term investments and zero debt on the books -- good for an astounding four year's worth of operating expenses using the Q1 2020 annualized run rate.
Paired with its fast growth and hefty profit margins, the coronavirus-fueled pullback has this high-quality growth stock trading at a relative value given its long-term potential.