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Morningstar | Largan’s 2Q2019 Results Positive but Long-Term Fundamentals Largely Priced in; Shares Fully Valued

Despite the overhang from the U.S. technology supply ban on Huawei, which led to a 25% pullback in Largan’s stock price between early May and June, it posted resilient results in the second quarter. Encouragingly, revenue grew 14.5% year over year, which is an improvement from 10.7% growth in the March quarter. Its gross margin rose to 69.6%, which is better than 64.2% from the previous quarter, and a percentage point better than the same period last year. We believe that much of the strong growth in the second quarter was driven by order wins from Samsung, which expanded its sourcing from external lens suppliers. Although key Apple’s suppliers such as foundry TSMC and printed circuit board maker Compeq Manufacturing have been conservative in their outlook for Apple-led demand in the second half of 2019, we believe that Largan is able to partially offset potential soft demand from Apple given its diversified customer base and market share gains within Samsung. As such, we continue to expect Largan to grow its revenue by 16% in 2019 and do not make any changes to our long-term forecasts.

We continue to be positive on the longer-term outlook for the firm, which is a major supplier of high specification lens technology to top smartphone brands and will be a key beneficiary of the rising penetration of multi-camera modules. Our narrow moat rating is intact as we are confident that Largan’s best-in-class lens design capabilities and scale will enable it to stay ahead of competitors and protect its long-term returns. We maintain our fair value estimate of TWD 4,750 per share. Although we are optimistic on the long-term fundamentals of the company, we believe that this has been largely priced in by the market and consider the stock fully valued at current levels.

As a key camera lens supplier to major smartphone brands such as Apple, Samsung, Huawei, we think that Largan will witness robust demand for its lens in the medium term as top smartphone OEMs focus on camera quality and adopt multiple rear cameras. We anticipate that the penetration rate of triple and quadruple-camera smartphones will reach 60% in 2023 from just 13% in 2018. Coupled with some market share gains in the front camera, we expect Largan to grow its revenue by 14.0% CAGR between 2019 and 2023, which is significantly higher than the global smartphone shipment volume growth of 1.2% CAGR during the same period. We continue to see Largan being the primary supplier of choice for high specification lens used in ultra-premium smartphone models such as Huawei’s P30 Pro, which sports a quadruple rear camera, and Samsung’s Galaxy S10, which boasts triple rear cameras. Notably, 80% of Largan’s lens shipment are 10 megapixels and above. Contrastingly, handset lens above 10 megapixels make up 47% of second player narrow-moat Sunny Optical’s overall shipment volume.

Besides the rising adoption of multiple camera modules in smartphones, we believe that the runway for advanced lens technology is still relatively long. We came out of Sunny Optical’s recent investor day in June with renewed optimism on the future of smartphone lens technology. We think that the continued strong demand for new and advanced lens technology is critical for Largan, which has long specialized in high specification lens with premium pricing. In addition to being the frontrunner in the development of 6 Plastic, or 6P, and 7 Plastic, or 7P, lens set, Largan revealed that it has concluded the development 8P lens set, which is ready for shipment and pending customer demand. We believe that we may see the deployment of 8P lens set for ultra-high end models sometime next year, as the rollout of 5G technology brings about advancement in the areas of virtual and augmented reality, which typically require premium quality lens. In addition to rear lens technology, Largan also noted that smartphone OEMs are exploring the possibility of making adjustments to the front camera design, with the likes of under-screen selfie camera and black coating lens technology having been discussed. Largan remarked that such design changes will also require more advanced lens design.