Himax: Fairly Priced Based On Normalized Gross Margin (NASDAQ:HIMX)

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I have written three articles on Himax Technologies (NASDAQ:HIMX). The first article was published in November 2020, right at the cusp of HIMX’s spectacular expansion of its gross margin (“GM”). The share price was around $5.8 at the time of publication. I pointed out in that article that there were tailwinds driving GM expansion and the shares could double. The shares climbed as high as $17.30, but the price advance stalled. At today’s ADS price of $9.4 and with TTM earnings per share (“EPS”) of $2.50, HIMX’s ADS is trading at a P/E ratio of 3.8. Either the market is grossly undervaluing HIMX or the market does not believe that this high level of earnings is sustainable.

I was in the former camp, but after much thought, I come to realize that the high level of GM is not sustainable and that the market is valuing HIMX based on a normalized GM basis. In this article, I will show that HIMX is fairly priced based on the thesis of a normalized GM.

Spectacular increase in GM was driven by premium pricing due to foundry tightness

HIMX is a fabless company and relies on its front-end and back-end partners to supply its products. The semiconductor industry has been under a very severe fab capacity constraint for the last 2 years. As a result, HIMX’s sales growth has been constrained. On the other hand, the capacity constraint has allowed HIMX to raise its ASP due to premium pricing. Even though its front-end and back-end suppliers have raised their prices, HIMX has been able to pass along its cost increase plus some, resulting in a spectacular growth in its GM and EPS. This is shown in Figure 1. Please note that the expected 1Q2022 data points are based on company guidance.

HIMX GM and EPS history

Figure 1: HIMX GM and EPS history. (HIMX’s earnings releases)

Before the end of 2020, HIMX’s GM had been bound in a relatively tight range in the low 20%. Its GM would rise to the high end of this range when HIMX shipped a larger mix of non-drive products, mostly driven by its shipment of wafer-level optics (“WLO”) products to Apple. In the last two years, WLO volume has declined as HIMX was unable to be designed in current Apple products.

The spectacular rise in the GM started in 4Q2020. Initially, I assumed that this result was due to a combination of cost reduction, higher GM product mix shift, and average selling price (“ASP”) increase resulting from foundry capacity tightness. However, when HIMX’s GM continued to rise quickly and reached beyond the 40% level, I began to question my assumptions.

Indeed, HIMX was taking advantage of the foundry tightness to move its product mix to higher GM products such as auto, TDDI for tablets, and Tcon. However, it is unrealistic to achieve such a rapid increase in GM due to product mix change over such a short period of time. I began to suspect that the premium price that HIMX was able to extract from its customers was the primary driver behind the GM increase. Should that be the case, then it is unlikely that the premium pricing and hence this high level of GM is sustainable when the foundry tightness eases.

HIMX is fairly priced based on a normalized GM in the 28% to 30% range

I believe that we have begun to witness such a closing of the supply gap. As part of its 4Q2021 earnings release print, HIMX guided for a sequential decline of its GM by a bit shy of 5% at the mid-point. Management cited some easing of expedite orders for 1Q. This may be a sign that supply may be beginning to catch up with demand.

The question then is: what is the normalized GM of HIMX? As noted earlier, HIMX’s historical GM was around the low 20% range. HIMX has increased its sales into the auto market, which tends to have higher GM. TDDI for tablets and Tcon will help to improve its corporate GM as well. However, the sales into the Chinese smartphone and TV markets, even for TDDI products, will tend to be more cutthroat. Higher margin products such as WLO, ultralow power AI image sensors, LCOS, and 3D sensing, have great promises, but volume production is not forthcoming in the near future. One can get a sense of the ceiling of HIMX’s GM of existing products by looking at the GM of Synaptics (SYNA) when it was primarily a leading provider of DDIC and TDDI products in the 2017 and 2018 time frame. SYNA’s GM was around 30%. Hence, it is likely that when the foundry supply tightness situation resolves itself, HIMX’s GM will not exceed 30%.

Based on this observation, I did a pro forma analysis of HIMX’s 2021 results, based on two lower GM assumptions at 30% and 28%. The results are shown in Figure 2. In Figure 2, I have assumed in my model that the COGS remains the same. The revenue is modeled based on the GM and COGS numbers. I also assumed that the other operating expenses are the same as the 2021 actual. This may underestimate the EPS results as HIMX might have reduced its stock award and other expenses in 2021 if actual GM was lower.

Model of HIMX 2021 results with lower gross margins.

Figure 2: Model of HIMX’s 2021 results with lower gross margins. (Author’s model)

Figure 2 shows a dramatic decline in net income per ADS with a lower GM. I have also applied a 20x P/E ratio to the earnings, which puts the calculated price of the ADS close to the current market value at the normalized GMs. What this analysis shows is that investors do not believe that the GM achieved in 2021 is sustainable. As a result, they have applied a normalized GM to their assessment of the value of HIMX. This resulted in the muted advance in HIMX’s share price.

Come this summer, HIMX may pay out a hefty dividend if it follows its historical dividend policy. HIMX may pay as much as $1.75 per ADS, which is 70% of 2021 EPS. This would translate to an 18% yield. However, I would not recommend that investors chase that yield as it may not be the norm going forward.

Share price may come under more pressure should normalized GM fall below this range

We have already started to see the beginning of the normalization of the GM in 1Q2022. HIMX guided to a 47% GM, a QoQ decline of a bit under 5%, with a concomitant decline in revenue. This revenue decline is driven by a GM decline as shown in my model in Figure 2. As the gap between supply and demand closes, I expect HIMX’s GM to continue to decline and its revenue continues to decline as well. Should its normalized GM settle at lower than the 28% to 30% range, HIMX’s share price may come under further pressure.

I have closed my position in HIMX and made a modest profit as I got in at the early phase of its GM increase. I made the mistake of not recognizing that the primary driver of the GM increase was the premium pricing of its products due to foundry supply tightness. This was clearly not sustainable in hindsight. I should have used normalized GM to model HIMX’s result. Should I have done that, I would have been more conservative in my share price expectation. This is clearly a lesson learned for me.

Takeaway

HIMX’s spectacular increase in GM was primarily driven by its ability to charge premium prices due to foundry supply tightness. The supply tightness is easing and HIMX’s GM will be normalizing. Its normalized GM may be higher than its historical GM due to HIMX’s work to shift its product mix to one with higher GM. Its current market price reflects a normalized GM in the 28% to 30% range. Should its normalized GM be below this range, HIMX’s share price may come under further pressure.

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