In a recent article entitled “Cracking Up”, The Economist looked at the trouble facing liquid crystal display panel (LCD) manufacturers. As noted in the piece, none of the company’s involved in production of LCD panels, including Samsung, LG, Sharp, or Panasonic (PC), makes any money from it (over time), despite segment growth of more than 30% in 2010 (188 million units shipped); in fact, from 2004 to 2010, the industry incurred a cumulative loss of roughly $13 billion, according to analyst Alberto Moel of Sanford Bernstein.
The biggest issue is clear, as noted in the article: “all are good, cheap, and do the same thing”. In addition, increased capacity which was originally meant to meet developed market demand was left unused as the economy stumbled; the result was a flooding of the market, driving prices significantly lower. From 2004 to 2008, the price of LCD panels fell by 80%, while the cost to manufacture the product only fell by 50%; what was originally a 2:1 discrepancy between average selling price and production costs ($5,000 per square meter versus $2,500 per square meter, respectively) has converged over the past decade, and is essentially even today.
This has worked its way down the supply chain, and ultimately falls on the shoulders of consumer electronics firms; Sony, for example, is currently losing $80 on every set that it sells, which is expected to be roughly 10 million units this year (an estimate of 20M was cut in half back in November). As noted in the article, “even Samsung, the biggest producer, has posted three quarters of losses on panel manufacturing this financial year”.
This goes back to what I talked about in my article from a couple weeks back entitled “TV’s, Tablets, and Solar – No Thanks”. Businesses without sustainable competitive advantages can only maintain outsized profits for so long before others take notice; as The Economist noted, “televisions are becoming like air tickets or long-distance phone calls”. On the other end of the spectrum, investors have the ability to invest in companies like PepsiCo (PEP), Procter & Gamble (PG) or Coca-Cola (KO), all of which have significant moats that would cost billions to even put a dent in.
When Warren (BRK.B) bought Burlington Northern for $34 billion in November 2009, Charlie Rose asked him a simple question: “why did you do it”?
As always, Warren focused on what is really important when buying a business: “Well, I felt it was an opportunity to buy a business that is going to be around for 100 or 200 years… sure, there’s a bad year from time to time; in the next 100 years, there will probably be 15 bad years, but I also know that the railroads will be essential to the country.”
Railroads and LCD panels are both essential to the country in their own way; the difference is that building a factory and buying some equipment is substantially different than laying 50,000+ miles of new railroad lines in a developed country. For investors, it’s important to remember that a growing industry isn’t necessarily a path to outsized value creation; without a moat to protect pricing power, it’s only a matter of time before outsized profits slip away in the name of lower prices.
About the author:
I hope to own a collection of great businesses; to ever sell one, I demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.