Himax Technologies: Even More Attractive Than Before, But Caution Is Warranted

seekingalpha04-09

Himax Technologies' revenues and financial metrics have trended down in 2023, causing a decline in its stock price.The company's balance sheet is still strong, but uncertainties regarding consumer ...

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Nikola Ilic Introduction I wanted to revisit Himax Technologies (NASDAQ:HIMX) to see how the company has progressed through ’23, which was another tough year for semiconductor companies. The company’s revenues and other financial metrics have trended down over the year, which sent its shares down around 18% since my first article (-12% total return). The reopening of China, a slowdown in automotive, and heavy declines in mobile and PC markets brought the shares down, however, it may seem to be the bottom, however, there is no rush to start a position since there are quite a few uncertainties regarding consumer demand. On paper, the company is a buy, but patience may help you get an even better entry point. I am sticking with my buy rating, as I believe the reward outweighs the risks. Briefly on Performance As of FY23, which ended Dec 31st ´23, and filed on April 2nd ´24, the company had around $191m in cash and equivalents, against around $35m in long-term debt, but also around $453m in short-term borrowings. I don’t think this is particularly alarming. The company’s short-term borrowing interest rate is about a third of a percent, and the company makes more in interest income than it pays out in interest expense. So far, the company’s balance sheet is still very strong. Now, let’s see how the company’s other important metrics fared in 2023. Starting with revenues, a bit of a mixed picture, as the last quarter saw quite a dip in top-line growth compared to the previous year, citing “subdued global demand, coupled with recession concerns”. Declines all across the board in the company’s business segments, but were ahead of the company’s guidance slightly. It was a tough economic environment for many semiconductor companies, especially for companies like HIMX that are involved in automotive and consumer electronics end-markets. These have seen a slowdown in 2023, especially consumer electronics, which only starting to see a recovery in 2024, with a long way to go, while the automotive segment is affected by the concerns of a recession, which is driving a slowdown in consumer demand for new vehicles.   Revenue (SA) Looking at the company’s margin progression, these have come down throughout the year also, which is not what anyone would like to see, however, I’m sure no one was surprised, since the aforementioned uncertainties and negative sentiment in the semiconductor business, especially related to automotive and consumer electronics. The persistent inventory problem, which is getting resolved slowly but surely, coupled with sluggish demand for products contributed to the decline in profitability. The company worked hard to deplete excess inventory and brought it to “satisfactory levels”, according to the transcript.  Aggressive destocking meant reducing prices, which affected margins considerably, however, now that inventory is where the company wants it, I would say we will see improvements over the next year. Margins have seen a huge hit over the last while and this is reflected in the company’s share price performance.   Margins (SA) With the decrease in the bottom line, a decrease in efficiency is apparent when looking at the company’s ROA and ROE also, and what a drop it has seen. At the beginning of the year, these were satisfactory, however, over the next three quarters, these just got worse and worse, meaning the management got worse at utilizing the company’s assets and shareholder capital, driven by the aforementioned demand slump and negative sentiment of the industry. It’s not an encouraging sign, but if the sentiment along with the demand improves over the next year or two, I would expect efficiency and profitability to improve along with them.   ROA and ROE (SA) In terms of competitive advantage against its peers, it is not easy to find some that trade publicly but looking at the company’s annual report I managed to come up with a few that do, however, these may not be perfect competitors as HIMX competes with them in certain areas and not all of them, so take these with a grain of salt. Nevertheless, the company’s ROTC, measures how efficiently the management utilizes the company’s capital structure to generate profits, we can see some low numbers across the board, except for Lattice Semiconductor (LSCC). The company is 10 times bigger than HIMX. I am looking for at least 10% from an investment, which it had achieved in FY22 and FY21 was even higher, so it seems that the company has been losing its competitive advantage and the moat is in trouble, however, the market conditions in the last couple of years have been exceptionally tough, so I don’t expect this to be the new norm, and fully expect these numbers to improve.   ROTC vs Peers (SA) Cash flow from operations seems to be bouncing back up, but if we zoom out a bit, we can see it is still very far from recent highs, but it is going in the right direction. The recent bounce can be attributed to the company's aforementioned aggressive inventory destocking. We will have to wait a couple of quarters to see how if this is an uptrend going forward.   Cash flow (SA) Overall, the trajectory the company was going throughout the year left a lot to be desired, however, it wasn’t surprising given the obstacles it faced over the period. I would like to see 2024 to be a year of a turnaround but that is yet to be seen and will go through my comments on the outlook in the next section. The company’s balance sheet is quite good still, and if the demand picks up, the company’s profitability should follow suit. Comments on the Outlook It looks like the company’s biggest challenge is the broad market, rather than what the company is producing, as it looks to be on top of its game when it comes to innovations. The automotive industry was the segment that was meant to help a lot of companies that are involved within it; however, not many predicted that this industry is going to slow down the way it did in the recent past. According to research, global automotive sales are expected to be subdued this year (2024), with a bright spot in the EV industry expected to see 21% growth y/y. That is all great and all; however, I am feeling a little bit skeptical. Back in 2022, people thought the transition to EVs would fuel automotive growth, now fast-forward to today and last year, and we see sales slowdown considerably, which tells us that it's not all positive. The cars are still quite expensive compared to their ICE counterparts, coupled with the uncertainty of the economy, and high-interest rates, consumers are putting the brakes on such large purchases until they have more clarity in terms of the economy and improvements in EVs. So, a slowdown in both EVs and ICE production will continue to weigh on the company’s top-line potential until cyclicality improves. In terms of consumer electronics, which is another major revenue generator for the company, the global smartphone market has been down badly in the last while, pretty much ever since the peak pandemic when everyone was upgrading their devices and preparing to stay indoors for a while. Naturally, it would be hard to follow such upgrade patterns, and so we saw back-to-back declines in sales in 2022 and 2023. Now, with the emergence of advanced innovations like AI on-device, consumers are looking to upgrade their handsets, however, it is just starting to ramp up. According to this report, the smartphone market is expected to grow just around 4% in ’24. There is not much growth yet, but I would expect this to accelerate in the following years, which means I am still expecting quite subpar performance from HIMX at least this year, with some recovery in ´25 and beyond. The company announced an upgrade of its proprietary AI module WiseEye, the WiseEye 2, which should be much faster and energy efficient than the original, with many applications, like digit reading, cameras, smart speakers, fitness trackers, and other smart home devices. The new processors make these products much more power efficient, which means you may not need to charge as often. There’s a lot of potential in this, however, I would like to see how the businesses can take advantage of the technology and whether it is going to be as popular as the company suggests. Nevertheless, anything that has AI on the edge should be of interest to many, but we will have to wait and see how it performs. The company’s more niche segments in the AR/VR space could fuel its top-line growth also, but I don’t expect this to be considerable. AR/VR is still far from being adopted by the masses due its clunkiness, lack of killer applications, and price, which is probably the biggest deterrent. In short, I am hoping for a turnaround in the mobile segment fueled by AI, and growth reacceleration in the automotive industry as these are going to be the main catalysts of growth for the company. While the niches are nice, and may add to the top-line growth, they are quite small for now, so I don’t expect these to move the needle much. Let’s look at some conservative numbers and what they tell us about the company’s intrinsic value. Valuation It’s been a while since I did a DCF analysis on the company. A lot has changed, so let’s see. For revenues, the management expects the beginning of the year to continue on the same negative trajectory, but pick up in the second half, as demand improves, and sales pick up. I am expecting a slow ramp-up this year, which means the first two quarters will see higher declines than the second half of the year improves, so for the year I am modeling around 5% y/y decline. After that, I am modeling a decent recovery of around 15%, which will linearly grow down to around 5% by FY33. I know it’s not the best way, but we cannot predict what the growth is going to be for the next 10 years, so I think a decrease in growth is better than being too optimistic about the company’s prospects. This way, I’m getting more margin of safety if I’m being conservative. Below are these estimates, with their respective CAGRs for each scenario.   Revenue Assumptions (Author) In terms of margins, these got hit quite a bit over time. I am modeling further declines over the next couple of years, however, I am going to improve gross margins to around 35% by FY33, as I think it makes sense that the company will see better profitability than the bad year of FY23.   Margins and EPS Assumptions (Author) For the DCF model, I went with the company’s WACC of 12.69% as my discount rate and 2.5% terminal growth rate on the base cases. See the below calculations. The WACC seems very high, but it will add to my conservative outlook and my margin of safety.   WACC Calculations (Author) Finally, I am also adding another 10% discount to the final intrinsic value, just to give myself an extra cushion of safety. I think 10% is sufficient given the balance sheet isn’t bad, and the outlook seems to be picking up. With that said, the company’s intrinsic value is around $8.78 a share, which means it is trading at quite a discount to its fair value.   Intrinsic Value (Author) Risks and Closing Comments The recovery might take much longer than anticipated and these marginal rebounds in the handset and PC markets are just an outlier and the segments might continue to see further declines, in which case, the company will have to provide lower guidance, and the shares continue their way down. The valuation above has to be taken with a grain of salt. It depends on whether we see a decent recovery in the mentioned markets and whether the company manages to attain much better margins than it has right now over the next decade. The new products and innovations that the company is pursuing may not be as popular as the management seems to think, and that may not translate into revenue catalysts that the company so desperately needs.  So, the company has continued to fall since my first article, and there are still many uncertainties regarding the economy and consumer spending, however, it does seem like the company is quite attractive at these prices. Therefore, I am sticking with my buy rating, but be cautious because the earnings are coming up, and there is no rush in starting a position right now and waiting until you hear what the management has to say about the outlook in general. The company does have some creative products and innovations, but they need to gain traction and become the catalysts that the management thinks they will be, which only time will tell.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2426774194"}