As the effects of the pandemic begin to ease, many households are still opting to stay home and watch movies and shows more than ever before. Thus, if you see ultra-high-definition 4K TVs flying off shelves this holiday shopping season, you might think about how to invest in these home entertainment big screens.
A great place to get started is Universal Display (OLED 2.23%). The company develops manufacturing processes and materials for use in OLED screen production. Universal has been a fantastic growth story in recent years, but the stock has fallen as of late. Following its third-quarter 2021 update, now looks like a good time to buy.
An underperforming stock, but for how long?
Universal Display (UDC) got hit hard last year and underperformed the market with just an 11.5% return. This year was expected to be a big rebound as spending on electronics with a screen made a comeback. While that rebound has happened, UDC shares are actually down 27% in 2021 with just a month-and-a-half to go until 2022.
The problem likely has to do with valuation (UDC currently trades for 47 times trailing 12-month free cash flow, still a premium price tag even after the recent sell-off). Stock performance aside, revenue was up 23% year over year in Q3, and up 42% to $407 million through the first nine months of 2021. Just over two-fifths of sales came from licensing and royalties paid by manufacturers for UDC's OLED tech patents and research, with the balance made up of product sales (the base materials needed to make an OLED screen).
Management expects full-year 2021 revenue to be $545 million at the midpoint of guidance, up 27% from 2020. In the longer term, UDC still believes it is in the early innings of growth. I agree, and the company provided some figures on the last earnings call to support that idea.
Solid growth with big long-term potential
The smartphone market was an early adopter of OLED screens. By the end of 2021, estimates point to about 45% of global smartphone units shipped having an ultra-high-definition display. That means there's still room to displace legacy LEDs in phones, but that development is already well underway.
TVs are an entirely different story. OLED TVs are expected to make up just 3% of the total global television market by year-end. Granted, there's a good reason for that. The average OLED TV is far more expensive than an LED unit. But as UDC's manufacturing partners invest in new production capacity and the cost to produce OLED decreases, UDC thinks this 3% figure will steadily increase in the years to come. That could work wonders for UDC's material sales. According to CEO Steven Abramson on the Q3 call:
Just to give you some context on what the TV market potential is from a display area perspective, approximately 5% OLED penetration of the TV market is greater than 50% OLED penetration of the smartphone market from a square meter standpoint. That has a lot of substrate area for material players like us.
In other words, because TV screens are so much larger than those on smartphones, there could be a massive uptick in demand for OLED materials in the next couple of years if ultra-high-def TV purchases continue to rise. Just one manufacturer, LG Display (LPL -0.67%), thinks 10 million OLED units shipped in 2022 is achievable -- up from 8 million this year. If that prediction transpires, it will equate to a boom in OLED materials sales for companies like UDC.
This doesn't include other medium-sized screen formats like laptops, which are also in the early stages of upgrading from older LED displays. Only 2% of this market utilizes OLED. Again, much like TVs, bigger screens mean more materials sold -- not to mention new patent royalties as more manufacturers make use of UDC technology. Along the way, UDC is also developing new manufacturing techniques to further drive down OLED costs. Its OVJP process (Organic Vapor Jet Printing) is still a few years away from commercialization, but UDC thinks it could be a multibillion-dollar revenue stream once it gets rolling.
Long story short, Universal Display stock has continued to tumble this year but the stock remains a long-term growth story. If you believe OLED will gradually find its way into more TVs and other larger screen formats such as laptops, this stock looks attractively priced after the Q3 report.