Universal Display Corporation: The Uptrend Remains After A Close Call

Universal Display Corporation (NASDAQ:OLED), a developer of organic light-emitting diode or OLED technologies and materials for the display industry, has managed to get back on track. The stock was showing signs of weakness after a strong rally early in 2023, and the stock actually fell below the trendline that had been in place all year, but the stock recovered, thanks in no small part to a Q2 report that soundly beat expectations. In doing so, the uptrend that seemed to be on its last legs remains intact. Why will be covered next.

OLED fends off a challenge

The chart below shows how 2023 has been a good year for OLED with the stock gaining 48.8% YTD. Note, for instance, how the lower ascending trendline has pushed the stock price higher all year. However, the rally in the stock had stalled by mid-2023 with the stock going sideways for months. The stock spent several weeks in June/July hugging the ascending trendline that kept the stock going higher, and it almost succeeded in breaking this trendline in early August, but the stock recovered in time to keep the trend alive.

The above was part of why a previous article from June speculated the existing trend might be undergoing a change, which is among the reasons why the stock was rated a hold. However, while sideways action was indeed the case for the following two months, this changed on August 4 after the release of the Q2 report sent the stock soaring higher by 13.8% in one day.

The stock had at that point fallen below the lower trendline, but the ensuing rally pulled the stock back above it, ensuring the continuation of the existing uptrend. Note that while the stock did fall below the trendline, the stock only spent two days below the trendline. Most would therefore consider the attempt to break through the trendline as a failed breakdown as it did not last long enough and the stock was able to get back above the trendline.

In addition, the rally helped power the stock through the $152.50-157.50 region, which is where the stock had twice before changed directions. With the ascending trendline still in place and the stock having broken through to new highs, it appears the stock is most likely heading higher next. Provided of course, the uptrend remains in place.

Why the Q2 report was able to do what it did

The above makes it clear the release of the Q2 report was a pivotal one for OLED. The stock had been struggling for months prior to the report, but the Q2 report managed to reinvigorate the stock and reignite the rally that had stalled by then. The report helped keep the uptrend intact to pave the way for higher stock prices, even though the uptrend came ever so close to being broken.

The Q2 report therefore deserves a closer examination, especially since the situation might have been very different if the report had not managed to keep the uptrend alive. On the surface, it's not hard to see why the market reacted very well to the Q2 report as it contained a number of positive developments, including handily exceeding estimates for the top and bottom line.

The consensus was that OLED would report GAAP EPS of $0.72 on revenue of $128.7M, but Q2 revenue increased by 7.3% YoY to $146.6M and GAAP EPS increased 19.5% YoY to $1.04, both significantly better than expected. The table below shows how the numbers for Q2 FY2023 are better QoQ and YoY.

Source: OLED Form 8-K

OLED beat EPS estimates by as much as $0.32 or 44.4%, which is very impressive. However, there are a couple of things worth mentioning to add some nuance to the numbers. First, EPS growth got a lift from $6.2M of interest income. If not for this, Q2 EPS would have been more like about $0.91 or $0.13 less than the reported $1.04. Note that OLED has cash, cash equivalents and investments to the tune of $756.5M on the balance sheet with no long-term debt.

Source: OLED Form 10-Q

Secondly, it appears all the Q2 growth can be attributed to just one customer. Note how in the table above customer C more than doubled its purchases from OLED. Customer C increased its purchases from $8.19M or 6% of Q2 FY2022 sales to $20.52M or 14% of Q2 FY2023 sales. Customer C increased its purchases by $12.33M YoY, which is more than the total YoY increase of $10M, from $146.6M to $136.6M, in Q2 FY2023. In other words, if not for customer C, Q2 revenue, and presumably EPS as well, could have shrunk instead of grown.

Nevertheless, OLED raised its FY2023 guidance, although by a sliver. The old guidance called for FY2023 revenue of $550-600M, but the updated one calls for FY2023 revenue of $560-600M. This implies a stronger second half to the year with H2 revenue of $283-323M since H1 revenue was $277M. Using this and with OLED earnings of $1.87 in H1, OLED is estimated to end FY2023 with EPS of around $4.00. This is $0.40 less than the $4.40 earned in FY2022. From the Q2 earnings call:

"As we move into the second half of the year, we expect this solid momentum to continue. For the year, we are narrowing our revenue guidance range to $560 million to $600 million. The OLED industry continues to lay the groundwork for promising growth in 2024 and beyond as a significant new OLED adoption cycle for the IT market is poised to commence."

A transcript of the Q2 FY2023 earnings call can be found here.

Why the stock may not have much more room to rally

OLED has earned $4.35 on a TTM basis, which translates to a P/E ratio of 36.7 with a stock price of $159.78. In comparison, the median in the sector has a P/E ratio of 25.2. With a market cap of $7.5B, OLED is valued at 12.4 times sales of $606.6M. OLED is a stock that trades at a premium, even if one can argue that a premium is justified given its relatively high margins, competitive positioning in the OLED market and other strengths.

Still, the stock has maintained the uptrend in the charts and people could be forgiven to think the stock is heading higher as a result. However, the stock may not have much more to go. While fair value is admittedly a subjective term, an argument can be made that OLED is trading close to fair value with a stock price of $159.78.

Recall how EPS grew from $1.24 in FY2018 to $4.40 in FY2022, which implies a CAGR of an impressive 37.25%. If EPS keeps growing at 37.25% per year on average in FY2022-2026 like it did in FY2018-2022 and with TTM EPS of $4.35, then fair value for OLED would be around $162, which is not far from the current $159.78.

This could help explain why the stock has essentially gone sideways after the Q2 post-earnings rally. The stock posted a 52-weeks high and intraday high of $166.57 on August 7, before ending the day at $164.60, but that was as good as it got. The stock came close on September 1 when it closed at $164.14, but there have been no new highs since early August as shown in the earlier chart. The stock is struggling to go higher. The fact that the stock is trading close to fair value might be the reason for this.

Investor takeaways

I am neutral on OLED. The stock remains in an uptrend, but it took a timely release of the Q2 report to prevent a close call from turning into something worse for OLED. The stock was in the process of breaking down, but the better-than-expected numbers in the Q2 report helped save the day to keep the uptrend in place.

There is a saying that the trend is your friend and the trend all year has certainly rewarded those long OLED. However, while the Q2 report kept the trend intact, it is worth mentioning that the strong results would not have happened without some fortunate turns of events. The Q2 numbers could have contracted if not for a big gain in interest income and if one customer had not decided to more than double its purchases from OLED. The Q2 report showed some impressive numbers and it helped keep the trend alive, but it could have turned out very differently. It also suggests business is not doing as well as the headline numbers suggest it is.

Furthermore, the sideways action has returned after a short, but powerful rally following the Q2 release. The stock seems to have stalled again and the last time this happened it took a Q2 report to prevent a breakdown, which in turn needed a couple of things to go in its favor to help it do what it did. The stock might not be so lucky again, especially if say a certain customer decides not to spike its orders.

The stock is also close to what may be fair value at $162. Keep in mind that this number assumes EPS will grow by 37+% on average per year, which is not impossible, but definitely no small feat to accomplish. In addition, while OLED demand is on the rise, as are use cases for OLED, OLED is facing a stiff challenge from advanced LCD technology. It remains to be seen how this competition for supremacy in the display market will play out.

Bottom line, the uptrend that has been in place all year remain in place, but the stock looks tired after the rally it had. Multiples are high and the stock may already be close to fair value, which may be why the stock is struggling to go higher. The stock is currently heading sideways and it may be due for another attempt at breaking down. The last time the Q2 report came to the rescue, but that was with a favorable turn of events. The next one might not be so fortunate.