U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

Transcription

1 Foldable devices to spark OLED super cycle Overweight (Initiate) Industry Report March 7, 217 Mirae Asset Daewoo Co., Ltd. [] Chuljoong Kim OLED production to focus on foldable displays The introduction of foldable devices appears imminent. Aggressive investments by global device makers, namely Samsung Electronics (SEC) and Apple, are expected to focus on foldable devices, not the current curved ones. For foldable devices, the number of possible folds determines the display size a device can accommodate. Notably, the display industry should see additional growth drivers as the displays of IT products grow larger. We are likely to see additional investments in flexible OLED at the end of the year, ahead of the expected launch of the foldable device market. In addition, growing panel sizes and panel makers adoption of new materials are expected to benefit materials producers. Of note, we estimate an annual sales volume target of 1mn 9 foldable devices would require flexible OLED capacity to increase to more than 1, sheets/month. For reference, producing 1mn 5.8 iphone units requires capacity of 35, sheets/month. Foldable: OLED materials producers to be the biggest beneficiaries In our view, OLED materials producers should benefit the most from the growth of the foldable display market. Demand for new materials used to produce foldable displays is expected to rise, while increasing display sizes should drive up demand for organic materials. As such, we advise investors to pay attention to Kolon Industries (1211 KS) and SKC Kolon PI (17892 KQ), which produce new materials such as colorless polyimide (CPI) and polyimide (PI) varnish. In addition, US-based UDC and Duk San Neolux (21342 KQ) are noteworthy as producers of organic materials for OLED. Given the likelihood of additional capex by panel makers for the production of foldable displays, we expect equipment makers to see new orders going forward. Assuming that mass production of foldable devices begins in 219, orders for related equipment should be placed around one and a half years earlier. As such, panel makers are likely to consider additional capex for foldable display lines at end-217, in our view. The scale of investments should be dictated by: 1) consumers response to test products (likely to be introduced this year) and 2) whether materials suppliers new production lines start operating on schedule. Producers of equipment for encapsulation and back-end processes deserve particular attention, in our view. Figure 1. Flexible OLED capacity required to produce 1mn foldable devices (' sheets/month) 14 Flexible OLED capacity for production of 1mn foldable devices (inch) Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

2 March 7, 217 Figure 2. Share performances of OLED plays LCD: Supply to determine the market The global LCD market has been swayed by supply since 215. Amid the overall slowdown in demand for applications using LCDs, including TVs, monitors, and smartphones, panel prices have grown more volatile due to: 1) increasing market forays by Chinese players and 2) panel makers shift to OLED production. The LCD market is expected to remain solid through 3Q. While supply area is projected to increase.8% YoY in 217, demand area is expected to rise 2.8% YoY in line with the increasing production of large-sized TVs. Although overseas panel makers new production lines are scheduled to come online in 3Q, strengthening seasonality and strong demand for large-sized and UHD panels are anticipated to offset supply area growth. Meanwhile, TV makers will likely carry out aggressive sales promotions for large-sized and UHD TVs in 2H17. For TV makers, 55 or larger TVs delivered higher margins due to the limited rise in panel prices. Margins of UHD TVs are also at least 1.5 times higher than those of FHD TVs. LG (LGD) boasts higher mixes of large-sized (43%) and UHD (45%) panels in its shipments relative to peers. We believe the company is capable of absorbing demand growth resulting from the arrival of high-demand season and TV makers growing need for high-end panels. Investment strategies for 217 OLED materials: Flexible OLED lines, in which panel makers made investments last year, are scheduled to come online in 217. Accordingly, producers of organic materials for OLED should enjoy earnings growth this year. In addition, the decline in prices should slow thanks to a more diversified customer base. Furthermore, once mass production of foldable displays begins, demand should grow in line with increasing display size. We recommend Duk San Neolux. OLED equipment: To be prepared for mass production of foldable devices in 219, panel makers are likely to consider additional capex at end-217, in our view. Assuming an annual sales volume target of 1mn 9 foldable devices, flexible OLED capacity should increase to over 1, sheets/month. Accordingly, equipment producers are expected to see new orders related to panel makers capex. Currently, domestic front-end process equipment producers are undervalued relative to overseas peers. We recommend Advanced Process Systems (AP Systems) and ICD. New beneficiaries of the rise of foldable displays: We advise investors to pay attention to companies in the supply chain for foldable displays. In our view, producers of materials (CPI and PI varnish) and equipment for encapsulation and back-end processes are worthy of attention. We recommend SKC Kolon PI. (1/1/9=1) 2, Front-end process equipment - domestic (L) Global OLED capacity (R) (Wbn, km2) 5, Back-end process equipment - domestic (L) SEC OLED capex (R) 1,5 OLED materials (L) Front-end process equipment - overseas (L) 4, 3, 1, 2, 5 1, 1/9 1/1 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 2

3 March 7, 217 C O N T E N T S I. Industry overview 4 LCD: Absence of key application 4 Supply-driven market 6 II. 217 LCD market outlook 8 LCD market to remain favorable through Margin differentiation via product mixes 9 Supply outlook: Ripple effects of production line contraction 12 Demand outlook: LCD demand to grow in terms of panel area 15 III. Foldable: Bigger area, bigger capacity? 16 Another breakthrough in sight 16 Flexible OLED capex schedule and capacity 17 1mn 9 foldable devices require capacity of over 1, sheets per month 19 Foldable: OLED materials producers to be biggest beneficiaries 22 OLED-manufacturing equipment order growth to hinge on foldable display investments 26 IV. Investment strategies for Review of OLED investment cycle 3 OLED materials: Production lines to begin operation 31 OLED equipment: Performance to diverge among equipment makers 32 Foldable display: Pay attention to materials makers 33 V. Issue: Will the Apple Watch adopt micro-led? 34 Micro-LED (mled) enables flexible displays 34 mled power consumption five times lower than OLED 35 mled process and technical issues 36 mled displays not yet cost-effective 37 Wearable devices as a potential application of mled 38 Global peer analysis 4 panel makers 4 -manufacturing equipment makers 41 OLED materials vendors 42 Key Recommendations 43 LG (3422 KS) 44 Samsung SDI (64 KS) 54 Duk San Neolux (21342 KQ) 63 SKC Kolon PI (17892 KQ) 7 Advanced Process Systems (5462 KQ) 77 ICD (491 KQ) 85 3

4 March 7, 217 I. Industry overview LCD: Absence of key application 1) Demand for IT devices remains stagnant Demand for IT devices continues to stagnate amid the absence of a key application. Growth in global notebook PC shipments has remained in negative territory since 211, with shipments contracting 6% YoY in 216. Desktop PC shipments are recovering from the steep negative growth in 215, but are unlikely to return to the meaningful growth path seen in the past. Smartphones and tablet PCs had been the key LCD applications since 211, with the smartphone market (W4tr in 216), in particular, sharply driving up LCD demand. However, the smartphone market s growth has slowed since 215. In particular, the LCD smartphone market is expected to remain on a downward trajectory amid increasing production of smartphones with OLED panels. Tablet PC shipments have also stagnated since hitting 24mn units in 214. Figure 3. Global notebook PC shipment trend Figure 4. Global desktop PC shipment trend (mn units) 3 25 Notebook shipments (L) YoY growth (R) (%) 4 3 (mn units) 2 16 PC shipments (L) YoY growth (R) (%) F F -2 Source: IDC, Source: IDC, Figure 5. Global tablet PC shipment trend Figure 6. Global smartphone shipment trend (mn units) 3 24 Tablet PC shipments (L) YoY growth (R) (%) 4 3 (mn units) 2, 1,6 LCD smartphone (L) OLED smartphone (L) LCD smartphone YoY growth (R) (%) , F 18F F 18F 19F 2F -2 Source: IDC, Source: IDC, IHS, 4

5 March 7, 217 2) TV market remains in a slump The LCD TV market has also been losing steam since 211. In 216, LCD TV shipments shrank.6% YoY to 22mn units. In the global TV market, the penetration of LCD TV has reached 99.6%. In China, the penetration rate is even higher. Despite low penetration in some emerging markets like India, we see only limited growth potential for the overall LCD TV market. TV demand is one of the most important factors determining the direction of the global display market. As TVs require larger-sized panels than other IT devices, they generate higher sales and make greater contributions to sales. Indeed, TV panels account for 7% of total display shipment areas, generating over 4% of total display sales. As new TV products fail to add value to customers, the TV market is being driven only by replacement demand. As LCD TVs take up 99% of the global TV market, any delay to the launch of meaningful new products should accelerate the price downtrend. To make matters worse, the market continues to see a steady inflow of new players. Even if replacement demand props up shipments, the value of the overall market should continue contracting in line with the price downtrend. Figure 7. LCD TV shipment trend Figure 8. LCD TV penetration by region (mn units) 3 25 LCD TV shipments (L) YoY growth (R) (%) 1 8 (%) Global North America 12 Western Europe China Other Asian countries F F Source: IHS, Source: IHS, Figure 9. % of TV panels in total shipment area (215) Figure 1. LCD panel revenue by application Notebook 6% Monitor 11% Smartphone & tablet 11% Other 2% (%) TV Monitor Notebook Smartphone & tablet Other TV 7% Source: IHS, Source: IHS, 5

6 March 7, 217 Supply-driven market 1) LCD market has shown high sensitivity to supply changes The LCD market has recently been sensitive to supply changes due to sluggish demand. Of note, panel prices, particularly for TVs, have seen higher volatility since demand started to weaken in 21, due to 1) the full-scale entry of Chinese panel makers and 2) a paradigm shift to OLEDs. We believe the display market is currently experiencing structural changes. In 215, TV panel prices fell on the operation of new 8G lines by Chinese makers, including BOE (725 CH) and CEC Panda (non-listed). At that time, Chinese makers focused on 32 panel production, while TV sales volume decreased YoY. As such, 32 panel prices dropped sharply from US$94 in January 215 to US$52 at the end of 1Q16. At the end of 1H16, panel prices picked up on supply reduction stemming from 1) a Taiwanese earthquake and 2) Samsung s failure in process improvements. The Taiwanese earthquake in February 216 resulted in lower utilization at Innolux s 6G line, and Samsung, which shifted to a new process for higher efficiency, faced yield issues. As such, supply disruptions drove up panel prices, leading to marked earnings improvements at panel makers in 2H16. Figure 11. Panel price trends (%) 1 Notebook Monitor TV 5 Less fluctuation Greater fluctuation /9 3/1 3/11 3/12 3/13 3/14 3/15 3/16 Source: WitsView, Figure 12. BOE s shipment area and 32 panel price trend Figure 13. TV panel prices and utilization rates of Innolux and Samsung (km2) 1,6 1,4 BOE's shipment area (L) 32" panel price (R) (US$) 1 9 (%) 12 1 TV panel price change (R) Innolux's 5, 6G line utilization (L) SDC's 8G line utilization (L) (%) 8 4 1,2 8 1, /15 7/15 12/15 6/ /14 7/14 12/14 7/15 12/15 6/16 12/16-8 Source: IHS, Source: HIS, 6

7 March 7, 217 2) Paradigm shift to OLEDs Higher LCD prices In 2H16, panel prices also climbed on supply issues. Samsung suspended the operation of its 5G L6 Ph1 and Ph2 lines in Cheonan between July and October 216. In December 216, the company also halted the operation of the 7G L7-1 line (mainly producing 4 TV panels) to convert it into an OLED line. The suspension of Samsung s L7 line caused panel prices, particularly for 4-49 panels, to rise. Of note, although the L7 line was suspended in December 216, the rise in panel prices had started six months before, as TV makers engaged in aggressive panel purchases in anticipation of a rise in 4 panel prices. Seasonally, the beginning of 2H was the time when TV makers strive to secure panel inventories for year-end sales. In addition, demand for 4 -or-higher panels was on the increase amid the shift to larger TV sizes. As such, 4 panel prices soared 6% from US$89 in early July 216 to US$142 at end- December 216. The display market remains sensitive to supply conditions. As we mentioned above, we believe the display market is currently experiencing structural changes due to 1) the fullscale entry of Chinese panel makers and 2) a paradigm shift to OLEDs. In 217, we expect the market to remain favorable thanks to LCD line reductions. However, it is time for Korean display makers to come up with a strategy for switching swiftly to OLEDs, as 1G-or-highr LCD lines should come online in 218 and beyond. Figure 14. L7-1 (7G) line currently being converted to a small/mid-sized OLED line Source: Media outlets, Figure TV panel price trend (US$) 15 4" TV panel price 13 2H16 +6% /15 9/15 12/15 3/16 6/16 9/16 12/16 Source: WitsView, Concerns about 4" panel shortage -> More panel buying L7-1 line shutdown point 7

8 March 7, 217 II. 217 LCD market outlook LCD market to remain favorable through 217 In 217, we expect LCD supply to remain tight, as supply area growth should continue to decrease due to the shift to OLEDs. We expect supply area growth to be.8% YoY, the lowest level in the LCD industry s history. Meanwhile, we forecast demand area growth at 2.8% YoY. Although we do not expect to see a significant increase in TV shipments, supply area growth will likely continue thanks to the shift to larger TV sizes. We believe supply will remain tight until the end of 3Q. Although supply will likely increase starting in 3Q due to the operation of new lines, the supply growth should be offset by demand arising from TV makers efforts to secure large-sized panels in preparation for highdemand season at the end of the year. Figure 16. Supply and demand area growth (%) 7 6 Supply area growth Demand area growth F 217F 218F Figure 17. LCD panel inventories (km2) 12, LG Samsung AU Optronics Innolux 1, 8, 6, 4, 2, 1/13 7/13 1/14 7/14 1/15 7/15 1/16 7/16 Source: IHS, 8

9 March 7, 217 Margin differentiation via product mixes In 217, we expect panel makers to display differentiated profitability depending on product mixes. In 2H16, TV makers saw margin deterioration due to higher panel prices. We project TV makers to embark on sales promotions, particularly for high-margin products such as 55 - or-higher TVs and UHD TVs. 1) 55 -or-higher TVs Price differences by panel size have widened since 2H16. 4 panel prices have recently climbed above TV sales prices, while 55 -or-higher panel prices have risen relatively modestly, leaving large-sized TV margins solid. In 2H, we expect demand for 55 -or-higher panels to increase thanks to the entry of highdemand season, benefitting top-tier panel makers that boast high product quality and stable production yields. Although some Chinese makers are increasing 55 and UHD panel shipments, they appear to be struggling with yield issues. Indeed, we think CSOT s 8G line yield has fallen from the level in early 216. Figure 18. OP margins of LGE and LGD (%) 2 15 LGE HE OP margin LGD OP margin Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 Figure 19. TV panel prices by size Figure 2. TV OP margins by size (9/15=1) 12 32" 4" 43" 5" 55" 65" (%) 4 6" 55" 4" 32" /15 12/15 3/16 6/16 9/16 12/16 3/17 Source: WitsView, -2 1Q15 3Q15 1Q16 3Q16 1Q17 Source: IHS, 9

10 March 7, 217 Figure 21. LGD s TV panel shipments by size (%) ~32" 32" 39~43" 49~5" 55" 55"~ 1 Figure 22. Samsung s TV panel shipments by size (%) ~32" 32" 39~43" 49~5" 55" 55"~ /14 7/14 1/15 7/15 1/16 7/16 Source: HIS, 1/14 7/14 1/15 7/15 1/16 7/16 Source: HIS, Figure 23. Innolux s TV panel shipments by size (%) ~32" 32" 39~43" 49~5" 55" 55"~ 1 Figure 24. AUO s TV panel shipments by size (%) ~ 32" 32" 39~43" 49~5" 55" 55"~ /14 7/14 1/15 7/15 1/16 7/16 Source: HIS, 1/14 7/14 1/15 7/15 1/16 7/16 Source: HIS, Figure 25. BOE s TV panel shipments by size (%) ~32" 32" 39~43" 49~5" 55" 55"~ 1 Figure 26. CSOT s TV panel shipments by size (%) ~32" 32" 39~43" 49~5" 55" 55"~ /14 7/14 1/15 7/15 1/16 7/16 Source: HIS, 1/14 7/14 1/15 7/15 1/16 7/16 Source: HIS, 1

11 March 7, 217 2) UHD TVs We estimate margins on 55 and 4 UHD TVs are 1.5 times and three times those of fullhigh-definition (FHD) TVs, respectively. We expect TV makers to launch aggressive sales promotions for premium TVs, including UHD TVs, to boost profitability. Given that LGD and Samsung generate 45% and 41% of their respective revenue from UHD panels, they will benefit more than their competitors, which have lower UHD revenue contributions and shorter production histories. Figure 27. OP margin comparison of FHD and UHD TVs (4 ) Figure 28. OP margin comparison of FHD and UHD TVs (55 ) (%) 6 4" UHD 4" FHD (%) 5 55" UHD 55" FHD Q15 3Q15 1Q16 3Q16 1Q17 Source: HIS, 1Q15 3Q15 1Q16 3Q16 1Q17 Source: HIS, Figure 29. Mix of UHD panels at LGD (%) UHD panel Other 1 Figure 3. Mix of UHD panels at Samsung (%) UHD panel Other Q14 1Q15 1Q16 1Q17 Source: HIS, 1Q14 1Q15 1Q16 1Q17 Source: HIS, Figure 31. Mix of UHD panels at BOE (%) UHD panel Other 1 Figure 32. Mix of UHD panels at AUO (%) UHD panel Other Q14 1Q15 1Q16 1Q17 Source: HIS, 1Q14 1Q15 1Q16 1Q17 Source: HIS, 11

12 March 7, 217 Supply outlook: Ripple effects of production line contraction In 217, we expect LCD shipment area to expand.8% YoY, the slowest pace of expansion in LCD s history. Shipment area growth resulting from the addition of new production lines this year will likely remain solid at 4.9%, close to the past two-year average. However, the switch to OLED lines should offset most of the growth. 1) New production lines coming online in 217 Innolux, BOE, and HKC each plans to crank up 8/8.6G lines in 2Q. Given that production yields are typically low in the initial stage of production, shipment area is unlikely to begin to grow until the start of 3Q. 1) Innolux: An 8.6G with a glass substrate production capacity of 45, sheets per month is coming online in mid-march. 2) BOE: An 8G line with capacity of 75, sheets per month is coming online in March. 3) HKC: An 8.6G line with capacity of 7, sheets per month is coming online in May. 4) LGD: The Guangzhou 2 (phase 2) 8G line with capacity of 5, sheets per month is coming online in, May, and the P8 (phase 7) line with capacity of 25, sheets per month is coming online in July. Once the 8.6G lines are brought online, the shortage of 49-5 TV panels should ease. As shown in <Table 1>, 8.6G lines are able to produce 5 and 58 TV panels more economically than existing lines. As such, the new 8.6G lines will likely be dedicated mostly to 5 panels. Once production begins to expand full-swing in 2H, supply should increase enough to absorb rising demand for larger TV screens. Table G economic panel cut comparison Gen. Glass size Economic cut Panel makers Gen8 216x246mm 32", 46", 6" Sharp Gen8 (8.5) 225x25mm 32", 48"/49", 55" Samsung, LGD, BOE, CSOT, AUO Innolux, Panasonic LCD, CEC-Panda Nanjing Gen (8.6) 225x26mm 32", 5", 58" Innolux (Taiwan) HKC (Chongqing, China) CEC-Irico (Xinyang, China) Gen8 (8.6+) 229x262mm 5", 58" CEC-Panda (Chengdu, China) Oxide Source: IHS, IHS, Figure G panel cut comparison Source: IHS, 12

13 March 7, 217 Figure 34. Crank-up schedules of 8G or higher lines Investors should further confirm equipment orders by Sharp, Foxconn, and Twinstar. Sharp recently held a groundbreaking ceremony at its 1.5G facilities in Guangzhou, with mass production scheduled to begin in June 219. Sharp is the only display maker that has successfully mass produced at 1G lines. If the 1.5G lines come online as scheduled, LCD s paradigm shift to 1G or higher may materialize earlier than the market has anticipated. Chinese display companies are forecast to begin operation of 1G-or-higher lines in 2H18. As mass production at these lines is projected to initially encounter production yield problems (just as Sharp did), shipment growth is unlikely to be felt in the market until end Source: IHS, 13

14 March 7, 217 2) LCD lines in contraction phase For 217, we expect to see a continued contraction in LCD lines amid the ongoing switches to OLED lines. Samsung and LGD are forecast to discontinue the following lines, which should mostly offset shipment area growth resulting from the addition of new production lines. 1 Samsung - L7-1: 7G line with capacity of 11, sheets per month (discontinued in December 216 and being converted to a flexible OLED line) - L6 (Ph3, 4): 5G line with capacity of 6, sheets per month (to be discontinued in April) - L6 Wing: 5G line with capacity of 55, sheets per month (to be discontinued in April) 2 LGD Figure 35. LCD line discontinuation schedule (estimate) - P4 (Ph2): 5G line with capacity of 4, sheets per month (discontinued in January) - P5 (Ph1): 5G line with capacity of 3, sheets per month (discontinued in January) - P6 (E): 6G line with capacity of 6, sheets per month (to be discontinued in October) Samsung s L7-2 line is unlikely to be discontinued and/or converted this year, given that: 1) TV and IT panels remain profitable, 2) its discontinuation would disrupt panel supply to a major customer, and 3) it will take some time until CSOT s 11G line comes online. In 2H18, however, we expect talks of a line conversion to emerge, as mass production at 1G lines begins full swing. ( : Production, : Shutdown ) Factory Phs Tech Gen K/Month 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1 a-si 5 3 Chonan L6 2 a-si a-si a-si 5 2 SDC 1 a-si/oxide 5 15 Chonan L6 Wing 2 a-si/oxide a-si/oxide a-si 7 7 Tangjong L7-1 2 a-si a-si a-si 5 3 Kumi P4 2 a-si a-si 5 6 LGD Kumi P5 1 a-si a-si 6 45 Kumi P6 3 a-si 6 3 E a-si a-si 5 3 AUO Linkou L5D 2 a-si a-si a-si a-si 5 4 Innolux Tainan Fab3 2 a-si a-si a-si 5 25 BOE Beijing B1 1 a-si a-si 5 15 Panasonic Himeji 1 1 a-si 8 25 Source: HIS, 14

15 March 7, 217 Demand outlook: LCD demand to grow in terms of panel area For 217, we expect LCD demand to grow 2.8% YoY in terms of panel area. Despite our conservative TV shipment assumptions, we still anticipate panel demand to expand as TV panels keep increasing in size. Indeed, the average TV panel size this year is estimated to be 1 bigger than the end-216 level. Moreover, TV brands are projected to aggressively promote large-sized TVs (55 or larger) and UHD premium TVs this year. Since 2H16, prices have sharply diverged by panel size, with 4 production costs surging above TV prices, while large panels (55 or larger) still offer hefty margins. UHD TVs are also profitable relative to FHD TVs. Meanwhile, there is a risk of TV shipments falling in 2H. Aggressive promotions of premium TVs may push TV prices higher, potentially leading to a reduction in TV shipments. Assuming that annual TV sales volume contracts by more than 4.5% YoY due to price hikes, demand growth (based on panel area) should trail supply growth (shipment area). If TV shipments fall short of market expectations, panel market conditions may deteriorate in mid-3q and beyond. Figure 36. LCD TV shipments trend and forecast (mn units) 3 LCD TV shipments (L) YoY growth (R) (%) F -2 Source: IHS, Figure 37. Avg. TV panel size trend Figure 38. Margin trend by TV panel size (inch) (%) 4 6" 55" 4" 32" F -2 1Q15 3Q15 1Q16 3Q16 1Q17 15

16 March 7, 217 III. Foldable: Bigger area, bigger capacity? Another breakthrough in sight In the display industry, the first major breakthrough in modern times came in the early 2s, when FPDs began to replace cathode-ray tube (CRT) displays. Within the FPD category, LCDs and PDPs initially vied for customers attention. However, irrespective of technological differences among FPDs, the most salient point from consumers perspective was the complete change in form factor from the deep dimensions of CRT to the flat dimensions of FPDs. FPDs eventually contributed to the emergence of IT devices that make the best use of flat screens, such as notebooks, smartphones, and tablets. We think the second breakthrough is at hand, with foldable displays. SEC is anticipated to debut a prototype device with a foldable display this year (to counter Apple s curved display, which is likely to be featured in the iphone 8). SEC is developing relevant materials and expanding capacity. How well the prototype is built and received in the market will help the electronics giant set its sales volume targets for foldable devices. We believe that display makers future performance will hinge on foldable displays. As such, display firms are anticipated to review plans to increase investments in flexible OLED, and panel area growth and the use of new materials should benefit relevant firms. While we eventually envision displays going off screen VR/AR, hologram displays that are unlimited and unrestricted by space, which should be negative to panel-type display makers it should take quite some time before the off-screen types are fully commercialized. Figure 39. technology development and applications 16

17 March 7, 217 Flexible OLED capex schedule and capacity We believe that mass producing foldable OLEDs will not be materially different from the way curved OLEDs are produced, although the exact details may remain unknown until the actual production lines are built. The manufacturing technology currently being developed involves simply replacing hard glasses and substrates with flexible materials, like films. In the front-end process, the only changes that we expect relate to encapsulation. We thus think it is important to examine the capex schedule and capacity of flexible OLEDs, in order to assess whether further spending will be required for volume production of foldable devices. At present, flexible OLED panels are mostly made on Gen-6 production lines. As a rule of thumb, one production line has a capacity of 15, sheets per month; in other words, this means 15, mother glasses can be produced in one month. The mother glass is typically cut to meet customer requirements. For a 5.5 smartphone panel, a single mother glass can produce roughly 264 panels. Thus, a 6G production line with a capacity of 15, sheets per month can manufacture roughly four million (264*15,) 5.5 smartphone panels per month. We expect Gen-6 flexible OLED capacity to reach 16, sheets per month by end-217. This is equivalent to a monthly capacity of 42mn 5.5 smartphones panels, or three times the end-216 level. Since 216, many panel suppliers have ramped up their OLED spending, spurred by the increasing adoption of OLED among set makers, including Apple. This year, we think the focus should be on capex for small/medium-sized OLEDs by non- Samsung companies. LGD s new Gen-6, E5 line for small/mid-sized flexible OLEDs (15, sheets per month) is expected to come online in 2H17 and is likely to produce displays for Chinese smartphones and automobiles. LGD is also investing in another line (E6) that will supply OLED panels for Apple s iphones. Chinese, Taiwanese, and Japanese panel suppliers investments in small/mid-sized OLEDs are also expected to get fully underway this year. We conservatively estimate that Gen-6 flexible OLED capex by Chinese, Taiwanese, and Japanese firms will be equivalent to around 13, sheets per month in 217, above the 15, sheets per month capex made by SDC for Apple in 216. With foreign companies ramping up their investments, we think investors should pay attention to Korean suppliers of flexible OLED equipment and their potential for new orders. Figure 4. Flexible OLED capacity forecasts (km2) 6, 5, Samsung LG BOE Tianma Ever Visionox Truly CSOT Sharp JDI 4, 3, 2, 1, 1Q14 1Q15 1Q16 1Q17F 1Q18F 1Q19F Source: IHS, 17

18 March 7, 217 Figure 41. Flexible OLED capex schedule (Korea) Source: IHS, Figure 42. Flexible OLED capex schedule (other) ( : Order Equipment, : Install, : Production) Source: IHS, 18

19 March 7, 217 1mn 9 foldable devices require capacity of over 1, sheets per month Foldable devices generally require more than twice the display area of existing devices, or even three to four times more area depending on how many times the device can be folded. We think the foldable devices that will actually be released will have panels in the range. Table 2 shows the number of panels that can theoretically be produced by size. As the panel area increases, the number of panels capable of being produced per mother glass significantly decreases. As mentioned earlier, one mother glass can produce around panels, or 48mn 5.5 panels per year. 1) 7 panels: Prototype unveiled by SEC at the CES 214 In theory, a Gen-6 mother glass can produce around 15 panels for 7 smartphones. Assuming a mother glass capacity of 15, sheets per month, this translates into a capacity of 2.25mn panels per month or 27mn panels per year. 2) 9 panels (16:9 aspect ratio, Figure 43) In theory, a Gen-6 mother glass can produce around 9 panels for 9 smartphones. Assuming a mother glass capacity of 15, sheets per month, this translates into a capacity of 1.35mn panels per month or 16.2mn panels per year. 3) 9.7 panels (Figure 44) In theory, a Gen-6 mother glass can produce around 84 panels for 9.7 smartphones. Assuming a mother glass capacity of 15, sheets per month, this translates into a capacity of 1.26mn panels per month or 15.1mn panels per year. Figure smartphone design by aspect ratio and folding points Unfolded 16:9 Screen Figure smartphone design 19

20 March 7, 217 Table 2. Calculating the number of panels capable of being produced from a 6G mother glass Number of panels Inch Height (mm) Width (mm) Panel area (mm2) per mother glass (sheets) , , , , , , , Figure 45. Number of panels capable of being produced from a 6G mother glass (units) 6 Number of producible panel units per 6G mother glass (inch) Figure 46. Number of 5.5 panels capable of being produced from a 6G mother glass 185mm Figure 47. Number of 9. panels capable of being produced from a 6G mother glass 185mm units units 15mm 15mm 11units 6units 2

21 March 7, 217 Thus, an annual sales target of 15mn units based on 9 foldable devices would require a capacity of around 15, sheets per month. An annual sales target of 1mn units would need a capacity of more than 93, sheets per month. And taking into account the need to flexibly respond to customer orders, we think capacity of over 1, sheets per month would actually be required. In the medium and long term, display area is likely to increase along with the number of folding points, suggesting further capacity expansions will be needed. Assuming SEC and Apple unveil mass-volume models in 219, we think discussions on investments for foldable smartphones will get underway at the end of this year, given that smartphone capex typically begins a year and a half ahead of mass production. While we are unlikely to see a repeat of the massive capex witnessed in 216, we think talks of investments will gradually take place, with potential traction coming from the status of materials suppliers and the public s reception to pilot products. A key point to watch is the development status of materials suppliers, as the technical advancement and production capacity of colorless PI (CPI) a core material is critical for the implementation of foldable displays. Kolon Industries has been working with SEC to develop CPIs and is currently investing in a mass production line that is scheduled to go into operation in February 218. Once its new line is completed, we estimate Kolon Industries will have a CPI capacity of around 1mn m 2 per year, which is enough to support 2mn units of 7 foldable devices. We thus forecast 2mn foldable devices will be produced in 218 at best. However, as foldable devices become more widely produced in 219, Kolon Industries is likely to weigh additional capacity expansions depending on manufacturers sales targets. We believe the timing and scale of Kolon Industries capacity ramp-up should be closely watched. Figure 48. Required capacity to meet foldable device sales target of 1mn units (' sheets/month) 14 Flexible OLED capacity for production of 1mn foldable devices (inch) Table 3. Required capacity to meet foldable device sales target of 1mn units Inch Number of panels produced per mother glass (sheets) Monthly output based on 6G 15K ( sheets) Annual output based on 6G 15K ( sheets) Required capacity to meet sales target of 1mn units ( sheets/month) ,695 92, ,95 59, ,96 47, ,75 44, ,35 16, ,26 15, ,17 14,

22 March 7, 217 Foldable: OLED materials producers to be biggest beneficiaries 1) OLED material suppliers to benefit In our view, OLED material suppliers should benefit the most from the growth of the foldable display market. Demand for new materials used to produce foldable displays is expected to rise, while increasing display size should drive up demand for organic materials. Materials used in foldable displays Colorless polyimide (CPI) CPI films are a key material used in foldable displays. While curved OLED smartphones now feature glass-based front covers, foldable smartphone front covers are based on CPI (foldable glass), which features high light transparency, heat/solvent resistance, and mechanical strength. At present, Kolon Industries, SK Chemicals (OEM: SKC Kolon PI), and Japan-based Mitsubishi Chemical are developing CPI films. PI varnish PI varnish refers to the liquid form of polyimide. While conventional rigid OLED displays feature glass-based TFT substrates, curved OLED displays use PI vanish (hardened in the PI curing process) to make flexible substrates. Currently, SU Materials, a JV between Samsung Electronics (SEC) and Japan-based Ube Industries, is the sole supplier of PI varnish for Korean display panel makers. However, amid the ongoing expansion of the flexible OLED display market, we think panel makers are now in discussions to diversify their supply bases, with conventional PI film makers highly likely to enter the PI varnish market. Base film Figure 49. New materials for use in foldable displays While curved OLED displays currently use polyester (PET) film as their base film, we expect PI films to replace PET films as the base film of foldable OLED displays going forward. Besides base films, foldable OLED displays also have heat-barrier films and electromagnetic/light-shielding films. Rigid OLED Curved OLED Foldable OLED 1) Kolon Industries 2) SKC (SKC Kolon PI) 1) SUM (monopoly) 2) SKC Kolon PI, etc. PI film maker 22

23 March 7, 217 Figure 5. Earnings trends of SU Materials, sole supplier of PI varnish (Wmn) 6, 5, 4, 3, 2, 1, -1, Revenue (L) Net profit (L) Net margin (R) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 (%) Figure 51. PI varnish market outlook (in terms of shipments) (tonnes) 1, 8 Bendable Curved Flat Foldable F 18F 19F 2F 21F 22F 23F Table 4. Candidate materials for base films PEN PC PI PES AryLite Strength Low thermal expansion coefficient Low hygroscopicity Low prices High light transparency Relatively simple process Thermal-resistant Chemical resistant UV-resistant Optical properties Thermal-resistant Chemical-resistant Weakness Low light transparency Birefringence Low chemical resistance High thermal expansion coefficient High gas permeability High prices High hygroscopicity High prices High absorbency High thermal expansion coefficient High prices High absorbency UV-resistant Limit temperature ( ) Thermal expansion coefficient (ppm/ ) Vendors 15 2 DuPont Teijin ~7 2 7 FIS BAYEL, Teijin, GE Mitsubishi Engineering, Samsung SDI Dupont Toray, Kaneka, UBE SKC Kolon PI BASF, Sumitomo Bakelite, I-Components 23

24 March 7, 217 Table 5. Small/mid-sized OLED materials suppliers Red Increasing display sizes to drive up demand for OLED organic materials Wider adoption of foldable displays by smartphone makers should benefit suppliers of OLED organic materials going forward. With full-fledged growth of the foldable device market unlikely to materialize until 219 or beyond, we do not expect foldable displays to generate significant earnings for display companies in the near term. However, we expect suppliers of OLED organic materials to exhibit significant growth from 1H17, backed by: 1) the start of operation of curved OLED facilities; 2) diversification of customer base and a subsequent decline in cost-cutting pressure from customers; and 3) high technological entry barriers. Apple s entry into the OLED smartphone market has been accelerating the small/mid-sized display market s shift in focus to OLED. While LGD and Chinese panel makers have also been foraying into the small/mid-sized OLED panel market, the number of key OLED materials suppliers has remained limited, which we think hints at marginal downside in prices of OLED materials going forward. As the global OLED organic materials market is small in size, manufacturing of OLED materials is mostly handled by divisions within companies. For reference, US-based UDC and DS Neolux (21342 KQ) are currently the only independent OLED materialsmanufacturing companies. Samsung LG Domestic Overseas Domestic Overseas EIL Doosan Electronics Dow Chem Heesung Materials Dow Chem ETL LG Chem, Samsung SDI Tosoh LG Chem Idemitsu Kosan Dopant - UDC - UDC Host Duk San Neolux Dow Chem LG Chem Dow Chem Dopant - UDC, Dow Chem - UDC, Dow Chem Green EML Samsung SDI, Doosan Host UDC, NSCC - Merck, Idemitsu Kosan Electronics Dopant - Idemitsu Kosan, SFC, Chisso - Idemitsu Kosan Blue Idemitsu Kosan, SFC, Dow Host - - Idemitsu Kosan Chem Duk San Neolux, Doosan HTL Idemitsu Kosan, Merck Idemitsu Kosan, Merck Electronics Figure 52. Samsung s organic materials & supply chain Figure 53. LGD s organic materials & supply chain Cathode EIL/ETL & aetl EIL/Yb: Doosan, Dow Chem ETL: Tosoh aetl: Doosan CPL: Duksan Neolux, Doosan Cathode EIL/ETL Cathode EIL: Heesung ETL: Idemitsu Kosan CPL: LG Chem EML & Prime layer H: Duksan Neolux D: UDC H: NSCC + NSCC R' D: UDC Duksan Neolux G H: Idemitsu Kosan D: SFC Merck B SYRI EML & Prime layer & EBL H: Dow Chem D: UDC H: Heesung (pre-mix) R D: UDC Idemitsu Kosan G' HBL: LG Chem LG Chem H: Idemitsu Kosan D: Idemitsu Kosan HTL HTL Duksan Neolux Doosan HTL Idemitsu Kosan Anode ITO Anode ITO Source: IHS, Source: IHS, 24

25 March 7, 217 Figure 54. HTL materials market breakdown (216) Figure 55. Red OLED materials market breakdown (216) Merck 2% LG Chem 2% Idemitsu Kosan 3% Duksan Neolux 23% Doosan 54% Duksan Neolux 43% Dow Chemical 55% Figure 56. Green OLED materials market breakdown (216) Figure 57. Blue OLED materials market NSCC 1% UDC 2% Merck 8% Idemitsu Kosan 3% Dow Chemical 4% SFC 11% Samsung SDI 86% Idemitsu Kosan 85% Figure 58. ETL materials market breakdown (216) Figure 59. Other functional materials market breakdown (216) Samsung SDI 3% Idemitsu Kosan 7% Other 13% Doosan 9% Tosoh 23% Duksan Neolux 29% LG Chem 9% Merck 13% Idemitsu Kosan 13% 25

26 March 7, 217 OLED-manufacturing equipment order growth to hinge on foldable display investments For now, we think the manufacturing process for foldable displays will not be materially different from that for existing flexible/curved displays, aside from slight changes in the packaging process and the replacement of rigid substrates and glass with flexible materials, like films. OLED-manufacturing equipment makers expect to win additional orders for foldable display equipment in 2H17, although OLED line investments are unlikely to increase as sharply as in 216. We think the scale of investments is likely to increase at a gradual pace this year, depending on: 1) customers response to test products (likely to be released by year-end); and 2) whether materials suppliers new production lines start operating on schedule. We also note the likely increase in orders for backend process equipment going forward, as display panel makers are likely to introduce new equipment needed for the mass production of foldable displays. Indeed, when the Galaxy S6 (featuring curved displays) was released, manufacturers of equipment used in additional processes for curved displays, including glass polishing, bubble-removal, and testing, exhibited remarkable share performances. We think manufacturers of equipment for encapsulation and backend processes will warrant increasing attention once panel makers begin discussions on ramping up foldable display production capacity. Figure 6. Flexible (curved) OLED process Figure 61. Glass-forming process for curved OLED-manufacturing process 26

27 March 7, 217 Appendix: Overview of foldable display market 1) Overview Flexible displays can be divided into curved, foldable, and rollable displays; for now, flexible OLED displays refer to curved displays. Given that LCDs can be used to manufacture slightly curved displays, we believe that current aggressive investments in OLED by panel/set makers suggest their focus is now on foldable and rollable displays, rather than curved displays. In flexible displays, the bending radius is important, as it determines the degree of display bending. The smaller the bending radius, the more flexible the display. For reference, the bending radii of the flexible OLED-based Galaxy Round (released in September 213) and the Galaxy Note Edge (released in 213) came in at 4R and 7-13R, respectively. The bending radius should play a key role in determining demand for foldable devices in the early stages of the market, as displays of foldable smartphones are usually more than twice as thick as those of conventional smartphones. Should the bending radius exceed 5R, we think the display would be too thick to be received well by customers. Figure 62. Bending radius & display Figure 63. Types of flexible displays 27

28 March 7, 217 2) Size of flexible display market HIS Technology forecasts the value of the global flexible display market to expand sharply from US$3.5bn in 216 to US$18.5bn in 22, with market growth to be driven by mobile panels in the near term. We expect the flexible display market to expand further to include TV and other larger applications once rollable display technology is commercialized. By display type, we expect demand for curved displays to drive growth of the flexible display market as a whole in the early phases, with the premium-product segment likely to see changes in form factor. The scale of investments in flexible OLED lines should be dictated by: 1) consumers response to test products (likely to be released by Samsung Electronics); and 2) whether materials suppliers new production lines start operating on schedule. Changes in display form factors usually lead to an increase in applications. Indeed, the commercial launch of curved OLED displays led to an expansion of applications, from just mobile devices to automobiles (e.g. dashboards). With the flexible display market likely to expand to include foldable and rollable displays going forward, we believe flexible displays will have a wider array of applications going forward. Figure 64. Flexible display market outlook (by display type) (US$bn) 2 16 Rollable Foldable Flat Curved Bendable F 17F 18F 19F 2F Figure 65. Flexible display market outlook (by application) (US$bn) 2 Smart watch OLED TV 16 Mobile phone Mobile PC E-book 12 Car monitor F 17F 18F 19F 2F Source: IHS, 28

29 March 7, 217 Figure 66. OPPO s foldable smartphones Figure 67. Lenovo s hybrid smartphones Source: OPPO Source: Lenovo Figure 68. LGD s rollable display (3R in bending radius) Figure 69. Samsung SDI s foldable display Source: LG Source: Samsung Figure 7. BOE s 4.8 flexible OLED display Figure 71. AUO s rollable display Source: BOE Source: AUO 29

30 March 7, 217 IV. Investment strategies for 217 Review of OLED investment cycle Looking at the OLED investment cycle at Samsung helps shed light on how display makers investments affect the share performances of related firms. After 211, OLED equipment producers shares trended down steadily in line with Samsung s capex reduction. However, the shares of materials producers were volatile. As they had not operated production lines, share prices have been highly affected by quarterly earnings. In addition, with Samsung as their single customer, the companies had significant exposure to issues such as price cuts and Samsung s diversification of supply channels. Back-end equipment firms displayed similar performances to those of front-end equipment makers. During the second investment boom, which began in 216, the shares of back-end equipment producers sharply outperformed those of other OLED-related companies. Due to the short investment period, Samsung was often supplied with a wide range of equipment from single vendors. In addition, investments in flexible OLED boosted demand for new back-end process equipment. In 217, we recommend a conservative approach to back-end process equipment makers, which are expected to see a decline in market share due to an increase in competitors. Market watchers are concerned about delayed OLED investments in China and an overall fall in investments (YoY). Nevertheless, we think that OLED front-end process equipment makers and OLED materials producers are deeply undervalued (compared to the previous investment cycle), and their stocks also look cheap. Front-end equipment makers, in particular, have seen their valuation gap with overseas peers widen following recent share price corrections. Domestic OLED front-end equipment companies are trading at an average P/E of 9.3x, vs. overseas peers 16.1x. Furthermore, the latest investment cycle is being driven by multiple customers (while the previous cycle was led by a single customer). A broader customer base means a better operating environment for equipment/materials makers. Despite conservative assumptions on China orders and market competition, OLED materials earnings appear poised to pick up full-swing starting this year. Flexible OLED lines have just begun to come online, and the customer base is broadening. Figure 72. OLED plays share performance and investment/capacity trend (1/1/9=1) 2, Front-end process equipment - domestic (L) Global OLED capacity (R) (Wbn, km2) 5, Back-end process equipment - domestic (L) SEC OLED capex (R) 1,5 OLED materials (L) Front-end process equipment - overseas (L) 4, 3, 1, 2, 5 1, 1/9 1/1 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 Source: IHS, 3

31 March 7, 217 OLED materials: Production lines to begin operation In 217, we expect OLED materials suppliers to see improved earnings as the production lines they invested in last year become operational. In particular, we believe OLED organic materials have limited risks of new competition due to their high technological barriers, and are entering a mid/long-term earnings growth cycle supported by customer diversification. Merck, which owns the core technology for liquid crystals (a key LCD material), enjoyed strong revenue growth and high margins during the LCD TV market expansion. From 24 to 28, LCD TV penetration rose rapidly from 5% to 51%. During that period, Merck s liquid crystal OP margin averaged 5.1%. During that period, Merck was able to maintain strong top-line and bottom-line growth, thanks mainly to high technological entry barriers and faster-than-expected LCD penetration. Sharp growth in LCD demand amid limited growth in key LCD materials supply helped benefit LCD material suppliers. In the liquid crystals market, Merck continues to form a duopoly with Japan-based Chisso. Apple s entry into the flexible smartphone market has been accelerating the small/mid-sized display market s shift to OLED. While LGD and Chinese panel makers have been making aggressive investments in small/mid-sized OLED, the number of key OLED materials suppliers has remained limited, which we think hints at marginal downside in prices of OLED materials in the current (second) capex cycle. Duk San Neolux (21342 KS) and USbased Universal (OLED US) are noteworthy as independent manufacturers of organic materials for OLED. Figure 73. Merck s LC sales trend Figure month forward P/E of UDC and Duk San Neolux (EURmn) 1, Liquid crystal revenue (L) LCD TV penetration (R) 51 (%) 6 (x) 6 Duksan Neolux's 12MF P/E UDC's 12MF P/E Average 1.3x Increase in valuation gap 1.9x /15 2/16 5/16 8/16 11/16 2/17 Table 6. Small/mid-sized OLED materials suppliers Samsung LG Domestic Overseas Domestic Overseas EIL Doosan Electronics Dow Chem Heesung Materials Dow Chem ETL LG Chem, Samsung SDI Tosoh LG Chem Idemitsu Kosan Red Dopant - UDC - UDC Host Duk San Neolux Dow Chem LG Chem Dow Chem Green Dopant - UDC, Dow Chem - UDC, Dow Chem EML Host Samsung SDI, Doosan UDC, NSCC - Merck, Idemitsu Kosan Electronics Blue Dopant - Idemitsu Kosan, SFC, Chisso - Idemitsu Kosan Host - Idemitsu Kosan, SFC, Dow - Idemitsu Kosan Chem HTL Duk San Neolux, Doosan Idemitsu Kosan, Merck Idemitsu Kosan, Merck Electronics Source: IHS, 31

32 March 7, 217 OLED equipment: Performance to diverge among equipment makers Panel makers are likely to consider additional capex at end-217 to meet rising demand for foldable devices. Assuming an annual sales volume target of 1mn 9 foldable devices, flexible OLED capacity should increase to over 1, sheets/month. We do not expect this year s investments to match the sizeable sum of last year, given the still-low demand visibility for foldable devices. Details regarding the size and timing of investments should be discussed further once SEC s prototype foldable product is released and consumer responses are fully measured. We also note concerns over delayed flexible OLED investments in China, Taiwan, and Japan. However, even our conservative estimate puts 6G investments by overseas display makers at a lofty 13,/month for 217, higher than Samsung s 15,/month in 216 (for OLED supply to Apple). At this level of investments, there should be a sufficient volume to supply to SEC, and flexible display equipment providers (namely, AP Systems and ICD) will be able to achieve medium- to long-term growth on the back of customer diversification and market share gains. Domestic OLED makers have seen their valuation gap with overseas peers widen following recent share price corrections. Domestic OLED front-end equipment companies are trading at an average P/E of 9.3x, vs. overseas peers 16.1x. Figure 75. Required capacity estimation assuming sales volume target of 1mn foldable devices (' sheets/month) 14 Flexible OLED capacity for production of 1mn foldable devices (inch) Figure 76. Relative share price performances of global OLED equipment providers Figure 77. P/E-EPSG of global OLED equipment providers (3/16=1) 3 25 AP Systems AMAT TEL ICD Coherent Ulvac (P/E, x) 25 2 V Tech Cohernt 2 15 Tel AMAT /16 6/16 9/16 12/16 3/17 Source: Bloomberg, Ulvac AP Systems 1 SFA 5 ICD (EPSG, %) Source: Bloomberg, 32

33 March 7, 217 Foldable display: Pay attention to materials makers Currently, a foldable display is manufactured by substituting polyimide (PI) or colorless polyimide (CPI) films for cover glass and TFT substrates in traditional displays. The process may change in the future, given that most panel makers are still researching and developing relevant technology. For the time being, however, Samsung is likely to continue to lead the technology. Thus, we advise investors to pay attention to the following materials used in this process. CPI: Kolon Industries, SK Chemical (OEM: SKC Kolon PI), and Japan-based Mitsubishi Chemical PI varnish: Exclusively supplied by SUM. But PI film producers, including SKC Kolon PI, may enter the market. Base film: PI films are expected to replace PET films as base films. Beside base films, foldable OLED displays also have heat-barrier films and electromagnetic/light-shielding films. <Please see page 22 for further details on materials> Once discussions on foldable OLED line capex start getting underway, suppliers of encapsulation and back-end process equipment (likely to be newly introduced) will warrant attention. The manufacturing process for foldable OLEDs should be similar to that for curved OLEDs, aside from changes in the encapsulation equipment (which protects organic materials from external elements like humidity), back-end testing, and fining process. In 215, when curved OLEDs were commercially produced, suppliers of newly adopted glass processing and fining equipment enjoyed a surge in new orders and share prices. Nexturn, a 3D glass processing equipment maker, saw its share price soar 74% from early 215 to late 216. Foldable displays have yet to be mass produced, but once mass production becomes possible, we expect discussions on the introduction of new equipment for additional processes to take place. Figure 78. New materials used in foldable displays Rigid OLED Curved OLED Foldable OLED 1) Kolon Industries 2) SKC (SKC Kolon PI) 1) SUM (monopoly) 2) SKC Kolon PI, etc. PI film maker 33

34 March 7, 217 V. Issue: Will the Apple Watch adopt micro-led? Micro-LED (mled) enables flexible displays Micro-LED (mled) display technology has attracted increasing interest ever since Apple acquired LuxVue Technology in 214. Some have speculated that the technology will be adopted in the Apple Watch starting from 218. But in the near term, we see little chance of mled penetrating into the flexible OLED market. mled is a self-emitting display consisting of microscopic LEDs (5-1 μm ). Theoretically, mled has a wide array of potential applications, including low-energy devices, ultra-large screens, and flexible displays. mled displays do not require color filters or BLUs, which are essential to LCD displays that utilize the light-modulating properties of liquid crystals. Moreover, unlike OLED displays, which require a packaging process to protect organic compounds from moisture, mled is not sensitive to external conditions. Such attributes make it possible to realize flexible displays and address the existing problem of breakages. Table 7. mled development history Timeline May 29 mled development history LuxVue Technology is founded in Santa Clara, California Jul 21 University of Strathclyde establishes a micro-led company called mled Dec 211 Texas Tech creates VGA display in 64x48 pixels by combining mled with CMOS Jan 212 Sony releases 55" crystal LED display (Full HD TV consists of 6.22mn mled) Jul 213 Illinois University launches X-Celeprint and files patent rights to mled water transfer May 214 Apple announces acquisition of LuxVue Apr 215 Apple opens secret lab in Longtan, Taoyuan to develop mled Apr 215 VerLASE announces that its color converter patent can be integrated with mled displays Oct 215 ITRI develops full color passive modules (Resolution: 44 PPI, Micro-LED conversion rate: Over 99%) Apr 216 PlayNitride demonstrates PixelLED technology at the Solid-state Lighting Show in Taiwan Jun 216 Sony unveils new display system using CLEDIS (crystal LED) Source: Media reports, Figure 79. LCD vs. OLED vs. mled 34

35 March 7, 217 mled power consumption five times lower than OLED Expectations are particularly high for mled due to its low power consumption. Extending battery life is among the biggest concerns for mobile device makers, including wearable devices and smartphones. Higher battery capacity has often come at the expense of design, and at times has even caused devices to overheat or catch fire. Thus it is significant that mled is expected to reduce power consumption five times compared to OLED. Despite ongoing battery capacity growth (iphone 5 s 1,44mAh iphone 7 s 1,96 mah), battery hours per charge have not improved significantly, as consumers spend more time connected to the internet and higher-end display panels consume increasing amounts of power. Battery hours are particularly important for smart watches, such as the Apple Watch, which have batteries that can last 18 hours on a charge. Apple s investment in mled is widely believed to be part of the firm s mid/long-term roadmap to extend battery life. Table 8. Comparison of LCD, OLED, and mled LCD OLED mled Mechanism Backlight/LED Self-illumination Self-illumination Visibility Intermediate Low High Luminance (cd/ m2 ) 3 (full color) ~ 14 (green) 15 (full color) ~ 13 (yellow) ~15 (full color) ~17 (blue/green) Contrast 2:1 Very high>1,:1 Very high>1,:1 Response time millisecond (ms) microsecond (μs) nanosecond (ns) Operating temperature ~6-5~7-1~12 Impact resistance Intermediate High Intermediate Product life Intermediate Intermediate Long Cost Low Low High Source: Industry data, Figure 8. Battery capacity and life by iphone model Figure 81. Smart watch battery capacity and hours per charge (mah) 2,5 2, 1,5 Battery capacity (L) Talk time (R) 1,44 1,56 1,81 1,715 (hours) 25 1, , iphone 4 4S 5 5S 6 6S 7 Source: Phone Area, 1 Source: Phone Area, 35

36 March 7, 217 mled process and technical issues The mled process consists largely of light source manufacturing and transfer. The process of fabricating 5-1 μm LED chips is critical for light source manufacturing. Chip fabrication methods include: 1) flip-chip, which uses electrical bonding technology; 2) heating; and 3) wet etching. In the transfer process, separated ultra-small LED chips are transferred to either flexible or rigid substrates. Studies of the electrostatic transfer element (ETE) and elastomer stamp methods are currently underway. The ETE method enables the selective transfer of necessary chips, but it could also damage LED chips due to the necessity of applying voltage. Elastomer stamp refers to the transfer of chips to either flexible or rigid substrates, by casting polydimethylsiloxane (PDMS, a viscous material) against a microfabricated master wafer. The method does not damage chips, as it does not use voltage. However, there are still technical hurdles that must be surmounted, including maintaining viscosity during the entire process. Figure 82. LED applications by size Source: KOPTI, Figure 83. mled uses LED chips as sub-pixels Figure 84. LuxVue s ETE method Source: YOLE, Source: KOPTI, 36

37 March 7, 217 mled displays not yet cost-effective Just like OLED, mled technology does not require backlight units (BLU), and can thus be used to make flexible displays. As the individual pixel elements in mled are formed from arrays of low-power LED, such displays would use less energy. However, we think commercialization of mled displays will take some time due to cost and technical issues (regarding the transfer process). The prices of such displays are hard to predict, as mled has yet to be mass-produced. However, we think pure-led displays (in which all pixels are composed of LED chips) may be too costly for use in large-sized and high-resolution products, as up to 25mn pixels are required to make a UHD (384 x 216) display. At the 212 CES, Sony unveiled its crystal-led TV (based on mled technology), which realized full-hd resolution using a total of 6mn mled units, with equal numbers of red, green, and blue LED chips (2mn each). Although Sony s mled display outperformed existing LED products in terms of contrast, color gamut, and response speed, it was not launched commercially due to high costs. In 216, Sony revealed its next-generation mled, CLEDIS, but it is likely to be used for outdoor display advertising (rather than household electronics) owing to the still-high manufacturing costs. Table 9. PPI and sub-pixels by product Company Product PPI Sub-pixels Sony Apple Crystal LED display 4 6,22,8 CLEDIS ,6 Apple Watch 38mm ,44 4K UHD TV (384X216) - 24,883,2 Figure 85. Sony s crystal LED TV (unveiled at CES 212) Figure 86. Sony s CLEDIS (216) 37

38 March 7, 217 Wearable devices as a potential application of mled If production yield issues (regarding the transfer process) are resolved, we expect mled technology to be used initially in smaller, lower-resolution displays, including some wearable devices. The high price will likely prevent its use in larger or higher-resolution displays, which means it is unlikely to be adopted in the Apple Watch in 218. The Apple Watch display contains around 27, pixels; as such, even assuming a unit price of W1 for one mled chip, it would still make up a significant proportion of total production costs. The cost of OLED for the existing Apple Watch stands at W22,/unit. Panel makers are endeavoring to cut mled manufacturing costs. Even if mled is adopted in the Apple Watch, the methodology would be to use not RGB LED chips, but rather color filters in either white LEDs (which would require development of technology to produce ultra-thin white LEDs) or BLU LEDs (which has the disadvantage of low efficiency). To sum up, we project only limited market penetration of mled in the near term. In its early stages, mled will likely be used only for some relatively low-resolution wearable devices and large displays for outdoor ads. We do not believe mled will be adopted in TVs (which have seen steady increases in resolution) or replace OLED, for which production costs have fallen to the levels of LCDs. In the medium to long term, we think the decline in LED chip prices arising from process improvements, particularly in chip bonding technology, deserves attention. Table 1. Breakdown of Apple Watch manufacturing costs (US$) Component Cost /TSP 2.5 Apps processor 1.2 Memory 7.2 Power management 5.5 BT/WLAN 3. User interface 5.5 Sensor 3. Battery.8 Other 16.5 Box contents 9. Total 81.2 Source: IHS, Figure 87. Color filters are used to cut manufacturing costs 38

39 March 7, 217 Table 11. Current status of mled development Company Product Description III-N Technology III-V Lab HKUS) X-Celeprint Green micro-led display 1μm-or below mled (first developed in 215) Passive micro-oled (.19 ) Micro - Transfer Printing (μtp) For use in wearable headgear, micro projectors, and wearable displays 256x192 mled 2 μm, Micro-LEDs 128x96. LuxVue Sony ITRI 2μm, 1μm, 3μm Micro-LED Crystal LED Smart glass/lens - μtp technology: Utilization of elastomer stamp to deterministically transfer microscale devices from their native substrates onto non-native substrates. LuxVue holds patents for a number of mled-related technologies and was acquired by Apple in 214 FHD display that is composed of 6.22m mleds (192x18x3) High-resolution display 1mn:1 contrast ratio. Based on patented pixel LED monitor technology 1mn:1 contrast ratio. Figure 88. Examples of mled Source: Media reports, 39

40 March 7, 217 Global peer analysis panel makers Table 12. Global peer valuation Market cap (Wbn, %, x) Revenue OP NP ROE P/E P/B EV/EBITDA 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F LGD 1,37 28,816 28,57 2,292 1,986 1,616 1, SEC 278,686 22, ,781 4,59 42,6 3,388 32, AUO 4,268 12,895 11, Innolux 4,543 12,148 11,54 1, Sharp 17,32 21,42 21, Japan 1,647 8,461 7, BOE 18,794 12,44 14, Average Source: Bloomberg, estimates Figure 89. Relative share performances of display panel makers (3/16=1) LGD SEC AUO Innolux JDI BOE 3/16 6/16 9/16 12/16 3/17 Source: Bloomberg, Figure 9. LGD s OP consensus trends (217F) (Wbn) 2,5 2, 1,5 1, OP consensus (L) Share price (R) Source: Bloomberg, (W) 35, 32, 29, 26, 23, 2, 3/16 6/16 9/16 12/16 3/17 Figure F P/B-ROE of global display panel makers (P/B, x) 1.8 Figure F P/E-EPSG of global display panel makers (P/E, x) BOE SEC AUO.6 LGD.3 JDI Innolux (ROE, %) BOE SEC AUO LGD Innolux (EPSG, %) , 1,2 1,4 Source: Bloomberg, Source: Bloomberg, 4

41 March 7, 217 -manufacturing equipment makers Table 13. Global peer valuation Market cap (Wbn, %, x) Revenue OP NP ROE P/E P/B EV/EBITDA 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F AP Systems ICD SFA 1,156 1,539 1, Wonik IPS Tera Semicon Applied Materials 46,37 14,792 15,335 3,73 3,869 2,831 3, Coherent 5,197 1,776 1, Tel 19,322 8,562 8,855 1,716 1,812 1,267 1, V Technology Ulvac 2,573 2,244 2, Average Source: Bloomberg, estimates Figure 93. Relative performances of display equipment makers Figure 94. Relative performances of display equipment makers (3/16=1) 5 4 AP Systems Tera Semicon Coherent ICD AMAT V Tech (3/16=1) 2 15 AP Systems SFA TEL ICD Tera Semicon Ulvac /16 6/16 9/16 12/16 3/17 3/16 6/16 9/16 12/16 3/17 Figure 95. Global display equipment makers 217E P/B-ROE (P/B, x) 6. Figure 96. Global display equipment makers P/E-EPSG (P/E, x) V tech AMAT 4. Cohernt 3. Tel Ulvac Wonik IPS AP system 2. SFA Tera Semicon 1. ICD (ROE, %) V Tech Cohernt Tel AMAT Ulvac AP Systems SFA ICD (EPSG, %)

42 March 7, 217 OLED materials vendors Table 14. Global peer valuation Market cap (Wbn, %, x) Revenue OP NP ROE P/E P/B EV/EBITDA 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F Duk San Neolux Samsung SDI 8,596 6,23 6, UDC 4, Dow Chemical 88,752 58,638 61,5 8,44 8,894 5,574 5, Idemitsu Kosan 5,99 35,963 36,289 1,228 1, Average Source: Bloomberg, estimates Figure 97. OLED material suppliers share price trends Figure month forward P/E: UDC vs. Duk San Neolux (3/16=1) 25 2 Duksan Neolux Samsung SDI UDC Dow Chemical Idemitsu Kosan (x) 6 5 Duksan Neolux's 12MF P/E UDC's 12MF P/E /16 6/16 9/16 12/16 3/17 2 Average 1.3x 1 11/15 2/16 5/16 8/16 11/16 2/17 Increase in valuation gap 1.9x Figure 99. Global OLED material suppliers 217F P/B-ROE (P/B, x) 8 Figure 1. Global OLED material suppliers 217F P/E-EPSG (P/E, x) 7 UDC 6 UDC Samsung SDI Duksan Neolux Idemitsu Kosan Dow Chemical (ROE, %) Dow Chemical Idemitsu Kosan Duksan Neolux (EPSG, %) Source: Bloomberg, Source: Bloomberg, 42

43 March 7, 217 Key Recommendations LG (3422 KS/Buy) Watch for re-rating of shares in 2H Global leader in display panel production Investment point 1: 217 OP to reach record high Investment point 2: Small/mid-sized OLED growth to ease worries Maintain Buy and TP of W38, Samsung SDI (64 KS/Hold) Prerequisites for further share growth Rechargeable battery and electronics materials producer Investment points: Electronic materials to continue stable growth Issue: Rechargeable battery business Maintain Hold; Mid/large-sized battery risks remain unresolved Duk San Neolux (21342 KQ/Buy) Flexible OLED lines coming onstream in 217 OLED materials supplier Investment point 1: Flexible OLED lines coming onstream in 217 Investment point 2: Positive effects of customer diversification Investment point 3: Foldable smartphones larger displays Initiate coverage with Buy and target price of W38, SKC Kolon PI (17892 KQ/Buy) Seeking to enter the foldable display market PI film maker Investment point 1: New materials to be adopted in foldable displays Investment point 2: Expansion of the heat-resistant sheet market Initiate coverage with Buy and target price of W18, Advanced Process Systems (5462 KQ/Not Rated) Many customers, but no competitor ELA and LLO equipment producer Investment point 1: Many customers, but no competitor Investment point 2: Encapsulation equipment for foldable displays Investment point 3: Streamlining business through spin-off ICD (491 KQ/Buy) Riding the OLED wave An OLED dry etcher and evaporator Investment point 1: Riding the OLED wave Investment point 2: China s OLED capex in 2H17 Initiate coverage with Buy and target price of W21, 43

44 March 7, 217 LG (3422 KS) Watch for re-rating of shares in 2H Technology (Maintain) Buy Target Price (12M, W) 38, Share Price (3/6/17, W) 27,9 Expected Return 36% OP (17F, Wbn) 2,74 Consensus OP (17F, Wbn) 2,61 EPS Growth (17F, %) 12.7 Market EPS Growth (17F, %) 16.9 P/E (17F, x) 5. Market P/E (17F, x) 9.6 KOSPI 2,81.36 Market Cap (Wbn) 9,983 Shares Outstanding (mn) 358 Free Float (%) 62.1 Foreign Ownership (%) 33.5 Beta (12M).5 52-Week Low 23,6 52-Week High 32,5 (%) 1M 6M 12M Absolute Relative LG KOSPI Global leader in display panel production LG (LGD) was established in 1985 as Goldstar Software. The company took over the LCD businesses of LG Electronics (LGE) and LG Semicon in 1998, and currently focuses on the production and sales of display panels for IT devices such as TVs, PC monitors, and notebooks. LGD supplies products to IT device makers such as LGE, Apple, and HP, and competes against rivals such as Samsung, AU Optronics (Taiwan), Innolux (Taiwan), and BOE (China). In response to the recent aggressive capacity expansion by Chinese panel makers, LGD has been focusing on adding new capacity for OLED panel production via ramp-ups and conversions of existing lines. Investment point 1: 217 OP to reach record high For 217, we expect LGD to post revenue of W28.8tr (+8.6% YoY) and operating profit of W2.7tr (+16.% YoY), with the latter figure marking a historic high. We expect the robust bottom-line performance to be driven by: 1) steady panel prices backed by solid market conditions and 2) a sales mix focusing on large-sized displays and UHD panels (which should allow the company to post stronger earnings than rivals). Investment point 2: Small/mid-sized OLED growth to ease worries Assuming that OLED panels are adopted in 7mn iphones in 217, LGD should see 25% YoY declines in mobile panel revenue and shipments. Even if the company manages to sell the LCD panels it formerly supplied to Apple to Chinese smartphone makers, the adoption of OLED in iphones would inevitably lead to a decline in LGD's mobile panel revenue. However, we expect LGD to become the second company to enter the market for flexible OLED panels, which is currently dominated by Samsung. The rampup of the company's E6 line in 218 should lead to rising sales of small/mid-sized OLED panels, helping to offset the impact of declining sales of LTPS LCD panels. The E6 line has the capacity to produce panels for 44mn 5.8 iphones per year. Meanwhile, the expansion of the E5 line, which is scheduled to start in 2H, should take center stage. A smooth ramp-up of the company's first 6G flexible OLED panel line would help offset some of the risks stemming from the expected decline in sales to Apple. Maintain Buy and TP of W38, We maintain our Buy rating and target price of W38, for LGD. Should the rampup of the E5 line in 2H prove successful, we could see a re-rating of LGD shares driven by eased concerns. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) 27,33 26,456 28,384 26,54 28,776 27,76 OP (Wbn) 1,163 1,357 1,626 1,311 2,74 1,792 OP margin (%) NP (Wbn) ,5 1,368 EPS (W) 1,191 2,527 2,71 2,539 5,64 3,824 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 44

45 March 7, 217 Investment point 1: Record-high operating profit for 217F For 217, we expect LGD to post revenue of W28.8tr (+8.6% YoY) and record operating profit of W2.7tr (+16.% YoY). We expect the robust bottom-line performance to be driven by: 1) steady panel prices backed by solid market conditions and 2) a sales mix focusing on large-sized displays and UHD panels (which should allow the company to post stronger earnings than rivals). 1) Healthy market conditions expected through 3Q In 217, we expect LCD shipment area to expand.8% YoY, the slowest pace of expansion in LCD s history. We attribute the slowdown to ongoing switches to OLED lines at top-tier panel makers. Meanwhile, LCD demand is forecast to grow 2.8% YoY in terms of panel area, as TV panels keep increasing in size. Panel prices and market conditions are projected to remain solid through 3Q, a strong season. Although rivals new production lines are coming online in 3Q, strong seasonality and robust demand for large-sized and UHD panels should offset shipment area growth. In 217, LGD is projected to continue to enjoy healthy top- and bottom-line on the back of stable market conditions. Figure 11. LGD s quarterly revenue and OP margin trends (Wtr) (%) 1 Revenue (L) OP margin (R) Q12 1Q13 1Q14 1Q15 1Q16 1Q17F Source: Company data, Figure 12. LGD s quarterly shipment area and ASP trends (mn m2) 12 Shipment area (L) ASP (R) (US$) Q12 1Q13 1Q14 1Q15 1Q16 1Q17F Source: Company data, 3 45

46 March 7, 217 2) Rising demand for large-sized and UHD panels Demand for large-sized and UHD panels are forecast to pick up sharply towards the second half of 217, as TV makers are anticipated to aggressively promote highmargin products to prop up falling profitability. A 55 TV is currently twice as profitable as a 4 one, and a 55 UHD TV is 1.5 times more profitable than a samesized FHD one. Meanwhile, large-sized and UHD panel prices are also expected to rise amid aggressive sales promotions. 6 and larger panels are already in tight supply, because Sharp has discontinued production. LGD s sales mix of 55 and larger panels is 38%, higher than rivals, and the mix of premium panels (including UHD displays) is around 45%. As such, we think LGD is well-positioned to take advantage of TV makers sales promotions in 2H. While Chinese rivals are ramping up supply of large-sized and UHD panels, they still lag behind their Korean counterparts in terms of panel quality and production yield. Figure 13. Margins by TV panel size (inclusive of distribution margin) Figure 14. Margins by TV panel resolution (inclusive of distribution margin) (%) 4 6" 55" 4" 32" (%) 5 55" UHD 55" FHD Q15 3Q15 1Q16 3Q16 1Q17 1Q15 3Q15 1Q16 3Q16 1Q17 Source: IHS, Source: IHS, Figure 15. Sales mix of 55 and larger panels (216) Figure 16. Sales mix of UHD panels (4Q16) (%) 5 Proportion of more than 55" (%) 6 Proportion of UHD panels LG Samsung AUO Innolux BOE LG Samsung CSOT Innolux AUO BOE Source: IHS, Source: IHS, 46

47 March 7, 217 3) Strong F/X exposure LGD has a high F/X operating profit exposure. Typically, a W1 monthly rise in the US$/KRW rate translates into a W8bn spike in the firm s monthly operating profit. A W5 rise/fall in the US$/KRW rate during a year leads to W48bn rise/fall in full-year operating profit. Indeed, the company s robust earnings in 4Q16 were partially attributable to a favorable F/X, as a W38 pickup in the US$/W rate (from 1,12 to 1,158) added around W8bn to operating profit. For our estimation of LGD s annual earnings, we used the Mirae Asset Daewoo macro analysis team s US$/W rate assumption of 1,171. Given the firm s strong F/X exposure, we advise investors to closely follow US$/W rate movements. Figure 17. Revision to OP estimates following changes to F/X rate assumption (Wbn) 1,2 1, 8 217F OP OP (-5 assumption in US$/W) OP (+5 assumption in US$/W) US$/W (R, estimate) (W) 1,25 1,2 6 1, ,1 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F 1,5 Table 15. OP estimate revisions following changes to US$/W rate assumptions US$/W 1,71 1,121 1,171 1,221 1,271 US$/W rate change (W) US$/W rate change (%) -9% -4% % +4% +9% Revenue (Wbn) 26,368 27,572 28,776 29,98 31,184 Operating profit (Wbn) 1,748 2,228 2,74 3,176 3,645 Pretax profit (Wbn) 1,81 2,34 2,793 3,279 3,762 Net profit (Wbn) 1,34 1,75 2,67 2,427 2,784 Revenue change F/X risk-free revenue (Wbn) Revenue exposed to F/X risk (Wbn) 25,792 26,996 28,2 29,44 3,68 Revenue (Wbn) 26,368 27,572 28,776 29,98 31,184 Revenue change (%) -8.4% -4.2%.% 4.2% 8.4% Operating profit change Revenue exposed to F/X risk (US$mn) 24,82 24,82 24,82 24,82 24,82 Raw material cost exposed to F/X risk (US$mn) 12,852 12,852 12,852 12,852 12,852 Other dollar-denominated expenses Dollar exposure (US$mn) 1,433 1,395 1,358 1,321 1,284 Dollar exposure converted to won 11,173 11,653 12,129 12,62 13,7 Annual OP change (Wbn) Annual OP 1,748 2,228 2,74 3,176 3,645 Annual OP change (%) -35.4% -17.6%.% 17.5% 34.8% 47

48 March 7, 217 Investment point 2: Small/mid-sized OLED to ease concerns Mobile panel revenue set to contract in 217 due to Apple s adoption of OLED panels LGD s share price has undergone a correction despite robust earnings, because of: 1) a projected fall in mobile display sales following Apple s adoption of OLED panels in iphones, and 2) supply glut concerns in view of the scheduled crank-up of China s 1G production lines. Last year, LGD is estimated to have shipped around 79% of its mobile panels to Apple (8% revenue share). Assuming that 7mn iphones adopt an OLED display, LGD s mobile revenue and shipments should each contract by 26% YoY. Furthermore, 6G LTPS lines of JDI, AUO, and Foxconn LTPS have been brought online recently, causing a pickup in supply amid plunging demand. Small- to midsized LTPS LCD panel prices are also anticipated to decline. Even if LGD manages to sell the LCD panels it formerly supplied to Apple to Chinese smartphone makers, the adoption of OLED in iphones would inevitably lead to a decline in LGD's mobile panel revenue. Assuming the company fails to divert the supply, we estimate a W2tr decline in mobile panel revenue. Table 16. Mobile panel revenue contraction following OLED adoption in iphones (estimates) 217F No. of iphones with OLEP panels (assumption) 5mn 7mn 1mn No. of iphones with LCD panels (mn units) LGD s panel shipments for iphone-use (mn units) YoY fall in panel shipments for iphone-use (mn units) YoY decline in mobile panel shipments (%) Table 17. Global small- to mid-sized LTPS LCD production capacity trend ( m2) Company Production line Phase Tech Gen 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 AUO Kunshan L6K LTPS 1 LTPS LTPS BOE Ordos B6 LTPS 1 LTPS LTPS CSOT Wuhan LTPS T3 1 LTPS LTPS Tianma Xiamen 2 LTPS 1 LTPS LTPS Xiamen LTPS 1 LTPS LTPS JDI Hakusan D3 LTPS 1 LTPS Mobara IPSA J1 LTPS 1 LTPS LTPS LTPS Nomi G5.5 LTPS D2 1 LTPS Sharp Kameyama 1 LTPS-C 1 LTPS LGD Kumi AP3 LTPS (P6) 1 LTPS LTPS LTPS Foxconn Kaohsiung LTPS 1 LTPS Total 1,427. 1, ,65.2 1, ,288. 2, , ,

49 March 7, 217 LGD to enter flexible OLED market Currently, Samsung is the only panel maker in the world that has operated a 6G flexible OLED line. Despite surging demand (Apple s flexible OLED adoption, and growing adoption of OLED panels by Chinese device makers), only a handful of firms are capable of producing OLED panels. Given this, Samsung s monopoly will likely continue through 218. For 217, we expect Samsung to post OLED panel revenue of W22.3tr (+38% YoY), and operating profit of W4.1tr (+61% YoY). LGD is likely to become the second company to enter the market for flexible OLED panels, which is currently dominated by Samsung. The company also has experience mass producing flexible OLEDs on its 4G fab for the Apple Watch. The operation of the company's new E6 line in 218 should lead to rising sales of small/mid-sized OLED panels, helping to offset the impact of declining sales of LTPS LCD panels. Currently, LGD is building capacity in its new E6 line to supply OLED panels for iphones, and aims to begin operations in 1H18. The company has so far invested in around 3, sheets/month worth of capacity and is expected to invest in another 15, sheets/month. Capacity of 45, sheets/month would have the ability to supply around 44mn 5.8 iphones per year. What matters at this point is the seamless operation of the E5 line, which is scheduled to start in 2H17. The 6G flexible OLED line is expected to produce panels for Chinese smartphones and automotive applications. The company has so far invested in 15, sheets/month, with further expansion a possibility. A smooth ramp-up of the company's first 6G flexible OLED panel line would help offset some of the risks stemming from the expected decline in sales to Apple. Figure 18. LGD s OLED capex schedule Source: IHS, 49

50 March 7, 217 OLED TV business Table 18. LGD s OLED TV panel earnings trends and forecasts LGD is the world s leading manufacturer of large-sized OLEDs, currently supplying to top TV makers like LGE and Sony. The company s large-sized OLED business has been growing at a slower rate than market expectations, mainly because of the low penetration of OLED TVs. In 216, around 65, OLED TVs were sold, accounting for just.3% of the total market. The slow growth in OLED TV sales has been primarily due to price. OLED TVs are still twice as expensive as LCD TVs, but those that have been released so far have failed to convince consumers they are worth the high price tag. In the past, consumers were willing to pay a higher premium for LCD TVs because they offered a new form factor (i.e. flat screen). More recently released OLED TVs have also been attempting to provide new form factors. At CES 217, Sony unveiled a crystal sound TV featuring LGD s OLED panel. The speaker was placed on the screen itself, with sound emanating directly from the panel a change in form factor that would have been impossible on traditional LCD panels. In the longer term, we believe TV manufacturers will focus on developing products with new form factors with strong appeal to consumers. A major advantage of OLED panels is that they enable such changes in form factor. LGD s large-sized OLED panel business succeeded in turning to a profit in 216 (based on EBITDA). While shipment growth has been slow, we expect profit margins to gradually improve on 1) cost savings through yield improvement and 2) the end of depreciation expenses. 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F Shipments ( units) ,569 55" " " Revenue (Wbn) ,528 55" " " Operating profit OP margin (%) EBITDA EBITDA margin (%) Figure 19. Price: LCD TV vs. OLED TV (55 UHD) Figure 11. Sony s crystal sound TV unveiled at CES 217 (US$) 6, 5, 4, 3, 2, 1, 55" OLED UHD (L) 55" LCD UHD (L) OLED ASP/LCD ASP (R) (x) Q15 3Q15 1Q16 3Q16 1Q17F 3Q17F 1.5 5

51 March 7, 217 Earnings forecasts and valuation For 217, we forecast LGD s revenue and operating profit to reach W28.8tr (+8.6% YoY) and W2.7tr (+16.% YoY), respectively, with the latter figure marking a historic high. We expect 1) panel prices to remain stable on the back of favorable industry dynamics and 2) LGD s earnings to outperform peers thanks to a positive product mix (towards large-sized and UHD panels). For 1Q17, we project revenue of W7.1tr (-11.1% QoQ, +17.8% YoY) and operating profit of W796.6bn (-11.9% QoQ, +1,96.6% YoY). Shipments should decline on seasonal weakness, but the ongoing strength in large-sized panel prices should drive up operating profit to the highest quarterly level since 211. We maintain our Buy rating and target price of W38, on LGD. Our target price is based on a P/B of.9x, the stock s average three-year multiple. Despite the continuation of strong earnings, the stock has come under pressure due to 1) concerns of a decline in mobile panel shipments due to Apple s OLED adoption and 2) risks of a cyclical deterioration following the operation of Chinese suppliers 1G lines. However, we believe the stock will move higher if the operation of the new E5 line in 2H17 moves along smoothly. Table 19. Valuation Note 12M FWD BPS (W) 41,927 Current P/B (x).7 Fair P/B (x) Historical three-year average; potential re-rating in 2H.9 following E5 operation Target price (W) 38, Current share price (W) 27,9 Upside potential (%) 36.2 Table 2. Quarterly and annual earnings (km2, US$/m2, Wbn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F 217F Shipment area (km 2 ) 9,483 9,961 1,86 1,77 1,312 1,288 1,596 1,887 39,692 41,74 42,83 ASP (US$/m 2 ) Revenue 5,989 5,855 6,724 7,936 7,56 6,895 7,191 7,634 28,384 26,55 28,776 Notebook 1,437 1,54 1,21 1,349 1,48 1,98 1,153 1,339 4,98 5,51 4,638 Monitor ,76 1,111 1,117 1,37 1,57 1,64 4,537 4,22 4,275 TV 2,276 2,284 2,622 3,16 3,157 3,15 3,413 3,475 1,92 1,198 13,195 Small/mid-sized 1,378 1,581 1,816 2,46 1,734 1,61 1,567 1,756 7,965 7,234 6,668 COGS 5,363 5,245 5,784 6,362 5,665 5,71 5,943 6,28 24,7 22,754 23,588 SG&A ,689 2,439 2,484 Operating profit ,626 1,312 2,74 OP margin (%) Growth (QoQ/YoY) Shipment area (km 2 ) ASP (US$/m 2 ) Revenue Notebook Monitor TV Small/mid-sized COGS SG&A Operating profit OP margin (%p) Source: Company data, estimates 51

52 March 7, 217 [Appendix] Company overview LGD was established in 1985 as Goldstar Software and later took over the LCD businesses of LGE and LG Semicon in The company s main business involves the production and sales of display panels for TVs, PC monitors, notebooks, and other IT devices. The company has 18 consolidated subsidiaries (including LG Guangzhou) and 14 equity-method affiliates. Major shareholders are LGE (38%), the National Pension Service (1%) and others (52%). LGD s main product is the TFT-LGD panel, used in TVs, PC monitors, notebooks, smartphones, and tablets. TV panels account for 39% of revenue, PC monitors 15%, notebooks and tablets 19% and mobile 27%. LGD is the world s top LCD supplier with a 2% market share by capacity (as of 216). Key rivals include Samsung, AU Optronics (Taiwan), Innolux (Taiwan), BOE (China), and CSOT (China). Recently, Chinese panel makers such as BOE and CSOT have been making rapid market share gains, driven by aggressive LCD capacity investments amid government support. LGD, on the other hand, has focused on converting its production lines to OLED. We believe the company will began to gradually lose share in the LCD market share from 2H18, when Chinese suppliers new 1G fabs are scheduled to go into operation. Figure 111. Ownership structure Figure 112. Revenue by application (216) LGE 38% Mobile 27% Notebook & tablet 19% Other 52% Monitor 15% NPS 1% TV 39% Source: Dart, Figure 113. LCD market share by capacity Figure 114. LCD capacity by generation Other 22% SDC 19% (mn m2) ~4G 5G 6G 7G 8G 12 BOE 12% LGD 2% AU Optronics 12% Innolux 15% 1Q6 1Q8 1Q1 1Q12 1Q14 1Q16 1Q8F 52

53 March 7, 217 LG (3422 KS/Buy/TP: W38,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue 28,384 26,54 28,776 27,76 Current Assets 9,532 1,597 11,29 11,946 Cost of Sales 24,7 22,754 23,588 23,5 Cash and Cash Equivalents 752 1,499 2,456 2,848 Gross Profit 4,314 3,75 5,188 4,26 AR & Other Receivables 4,188 5,48 4,856 5,47 SG&A Expenses 2,689 2,439 2,484 2,414 Inventories 2,352 2,288 2,21 2,288 Operating Profit (Adj) 1,626 1,311 2,74 1,792 Other Current Assets 2,24 1,762 1,696 1,763 Operating Profit 1,626 1,311 2,74 1,792 Non-Current Assets 13,46 14,287 15,811 17,58 Non-Operating Profit Investments in Associates Net Financial Income Property, Plant and Equipment 1,546 11,865 13,721 15,137 Net Gain from Inv in Associates 19 5 Intangible Assets Pretax Profit 1,434 1,316 2,793 1,96 Total Assets 22,577 24,884 27,2 29,4 Income Tax Current Liabilities 6,67 7,58 6,916 7,258 Profit from Continuing Operations 1, ,67 1,411 AP & Other Payables 4,264 5,77 4,884 5,76 Profit from Discontinued Operations Short-Term Financial Liabilities 1, Net Profit 1, ,67 1,411 Other Current Liabilities 927 1,313 1,264 1,314 Controlling Interests ,5 1,368 Non-Current Liabilities 3,265 4,364 4,754 5,164 Non-Controlling Interests Long-Term Financial Liabilities 2,88 4,111 4,511 4,911 Total Comprehensive Profit 1, ,67 1,411 Other Non-Current Liabilities Controlling Interests ,943 1,326 Total Liabilities 9,872 11,422 11,67 12,422 Non-Controlling Interests Controlling Interests 12,193 12,977 14,83 15,993 EBITDA 5,1 4,447 6,118 5,58 Capital Stock 1,789 1,789 1,789 1,789 FCF (Free Cash Flow) Capital Surplus 2,251 2,251 2,251 2,251 EBITDA Margin (%) Retained Earnings 8,159 8,885 1,712 11,91 Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity 12,75 13,462 15,35 16,582 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities 2,727 3,679 5,524 5,84 P/E (x) Net Profit 1, ,67 1,411 P/CF (x) Non-Cash Income and Expense 4,361 3,846 4,21 4,274 P/B (x) Depreciation 2,969 2,757 3,94 3,534 EV/EBITDA (x) Amortization EPS (W) 2,71 2,539 5,64 3,824 Others CFPS (W) 15,49 13,352 17,519 15,887 Chg in Working Capital -2, BPS (W) 34,76 36,269 41,373 44,697 Chg in AR & Other Receivables -1, DPS (W) Chg in Inventories Payout ratio (%) Chg in AP & Other Payables -1, Dividend Yield (%) Income Tax Paid Revenue Growth (%) Cash Flows from Inv Activities -2,732-3,272-4,898-5,2 EBITDA Growth (%) Chg in PP&E -1,918-3,726-4,95-4,95 Operating Profit Growth (%) Chg in Intangible Assets EPS Growth (%) Chg in Financial Assets Accounts Receivable Turnover (x) Others Inventory Turnover (x) Cash Flows from Fin Activities Accounts Payable Turnover (x) Chg in Financial Liabilities ROA (%) Chg in Equity ROE (%) Dividends Paid ROIC (%) Others Liability to Equity Ratio (%) Increase (Decrease) in Cash Current Ratio (%) Beginning Balance ,499 2,456 Net Debt to Equity Ratio (%) Ending Balance 752 1,499 2,456 2,848 Interest Coverage Ratio (x) Source: Company data, estimates 53

54 March 7, 217 Samsung SDI (64 KS) Prerequisites for further share growth Technology (Maintain) Hold Target Price (12M, W) - Share Price (3/6/17, W) 125, Expected Return - OP (17F, Wbn) 1 Consensus OP (17F, Wbn) -22 EPS Growth (17F, %) Market EPS Growth (17F, %) 16.9 P/E (17F, x) 15.8 Market P/E (17F, x) 9.6 KOSPI 2,81.36 Market Cap (Wbn) 8,596 Shares Outstanding (mn) 7 Free Float (%) 74.7 Foreign Ownership (%) 36.5 Beta (12M) Week Low 89,3 52-Week High 129, (%) 1M 6M 12M Absolute Relative Samsung SDI KOSPI Rechargeable battery and electronics materials producer Samsung SDI produces rechargeable batteries and materials for semiconductor and display. Its businesses are largely divided into: 1) small-sized battery, 2) mid/large-sized battery, and 3) electronic materials. In 216, small-sized batteries made the greatest contribution to revenue, generating 46%, followed by electronic materials (35%) and mid/large-sized batteries (19%). Investment points: Electronic materials to continue stable growth 1) Semiconductor materials: By 218, SEC s DRAM and NAND capacities are projected to expand 8% and 1%, respectively, from current levels, which should also boost Samsung SDI s materials revenue. In light of the stronger margins of semiconductor materials relative to those of Samsung SDI s other key products, the business is expected to drive up the company s profitability until the second boom of the mid/large-sized rechargeable battery market. 2) materials: Polarizer sales are expected to increase steadily from 217 onwards on the back of 1) capacity expansion from the operation of the Wuxi plant in China and 2) customer diversification (mainly Chinese companies). OLED materials are anticipated to enter a growth cycle in 217 as new lines in which Samsung invested (following Apple s decision to adopt OLED in its devices) come online. Over the medium to long term, the display materials business is expected to maintain stable growth as 1) the decline in prices should slow thanks to a more diversified customer base and 2) demand for organic materials should increase as the foldable device market comes into view. Issue: Rechargeable battery business 1) Small-sized battery: The small-sized battery business is expected to steadily improve in 217. Although revenue from cylinder-type batteries is anticipated to decline due to China s EV battery regulations, overall revenue is forecast to improve YoY, albeit slightly, driven by polymer and non-it-use (power tool) batteries. 2) Mid/large-sized batteries: We believe that revenue and margins of ESS-use mid/large-sized batteries will improve steadily. However, risks related to Chinese regulations should continue to affect EV batteries, one of Samsung SDI s key products. If Chinese regulations ease and the company receives the 5th battery certification from the Chinese government, earnings should grow sharply. Maintain Hold; Mid/large-sized battery risks remain unresolved In our view, Samsung SDI has already embarked on an earnings recovery path. Its stake in Samsung should also provide a boost to the company s shares. However, share price is unlikely to advance further unless China risks dissipate completely. We will revisit the stock for an investment rating upgrade once China risks are fully removed. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) 3,428 5,474 7,569 5,21 6,65 6,792 OP (Wbn) OP margin (%) NP (Wbn) EPS (W) 2,768-1, ,116 7,889 9,8 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 54

55 March 7, 217 Investment points: Electronic materials to continue stable growth Samsung SDI s electronic materials business breaks down into semiconductor and display materials. Semiconductor materials include materials for spin-on-hardmask (SOH) and spin-on-dielectric (SOD) processes. materials include polarizers (used for LCD cells), color resists, anisotropic conductive films (ACF), and organic materials. 1) Semiconductor materials Samsung SDI s semiconductor materials sales should move in line with changes in semiconductor production capacity. In 217, semiconductor materials sales are anticipated to shrink as SEC s DRAM capacity is expected to decline slightly due to process migration. However, they will likely improve afterwards in light of SEC s 1) additional DRAM investments (4, sheets/month) in 2H and 2) steady expansion of NAND investments. SEC s DRAM and NAND capacities are projected to expand 8% and 1%, respectively, from current levels by 218. Of note, semiconductor materials boast stronger margins (estimated OP margin of over 2%) relative to Samsung SDI s other key products thanks to high technical barriers to entry. The business is expected to drive the company s profitability until the rechargeable battery businesses normalize. Figure 115. SEC s production capacity and Samsung SDI s semiconductor materials revenue trend (K wpm) 1,2 1, SEC's DRAM capacity (L) SEC's NAND capacity (L) Samsung SDI's semiconductor materials revenue (R) (Wbn) Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18 Figure 116. SOH process Figure 117. SOD process 55

56 March 7, 217 2) materials Samsung SDI s display materials include polarizers and OLED materials. In 216, overall display materials revenue was broken down into: polarizers (62%), OLED materials (17%), and others (2%). Polarizer sales tend to move in line with LCD demand. Amid the slowdown in LCD applications demand, the company s polarizer revenue remains stagnant. However, polarizer sales are expected to increase steadily from 217 onwards on the back of 1) capacity expansion from the operation of the Wuxi plant in China and 2) customer diversification (mainly Chinese companies). OLED materials are anticipated to enter a growth cycle in 217 as new lines in which Samsung invested last year (following Apple s decision to adopt OLED in its devices) come online. The company is scheduled to supply green host, which accounts for the lion s share of its OLED materials revenue, to Apple. Over the medium to long term, the display materials business is expected to maintain stable growth as 1) the decline in prices should slow thanks to a more diversified customer base and 2) demand for organic materials should increase as the foldable device market comes into view. Figure 118. Samsung SDI s polarizer revenue trend (Wbn) 3 Polarizer revenue Q9 1Q11 1Q13 1Q15 1Q17F Figure 119. Samsung SDI s OLED materials revenue trend (Wbn) 6 OLED materials revenue Q12 1Q13 1Q14 1Q15 1Q16 1Q17F 56

57 March 7, 217 Issue: Rechargeable battery business 1) Small-sized batteries Samsung SDI s small-sized batteries are divided into cylinder, prismatic, and polymer batteries. While cylinder batteries are widely used for IT tools and Chinese EVs, prismatic and polymer batteries are often used for IT devices like smartphones and tablet PCs. In 216, cylinder batteries made up 65% of the company s smallsized battery revenue; prismatic 16%; and polymer 19%. In the past two to three years, the small-sized battery businesses encountered significant challenges. In 215, the business remained in the red due to one-off costs related to the conversion of production lines resulting from major customers shift from prismatic to polymer batteries. In 216, provisions related to the Galaxy Note 7 issues weighed on earnings. The small-sized battery business is expected to improve steadily in 217. Although revenue from cylinder-type batteries is anticipated to decline due to China s EV battery regulations, overall revenue is forecast to improve YoY, albeit slightly, driven by polymer and non-it-use (power tool) batteries. The early batch of the Galaxy S8 is expected to use the company s polymer batteries. Over the medium to long term, however, we see only limited upside to the smallsized battery business in light of 1) an expected decline in IT device demand and 2) the narrowing technology gap with Chinese competitors. Figure 12. Samsung SDI s small-sized battery revenue and OP margin trend (Wbn) 1,2 1, Revenue (L) OP margin (R) (%) Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17F -15 Figure 121. Small-sized battery revenue by battery type Figure 122. Samsung SDI s cylinder battery (1865) (%) Cylinder Prismatic Polymer Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17F Source: Samsung SDI, 57

58 March 7, 217 2) Mid/large-sized batteries Samsung SDI s mid/large-sized batteries include EV- and ESS-use batteries. The business is expected to serve as a major growth engine for the company going forward. ESS is increasingly garnering attention in line with the worsening imbalance between power supply and demand. ESS has emerged as a more cost-efficient option to ensure constant power load and stabilize power supply. Samsung SDI s ESS battery business recorded W18bn (+69.9% YoY) in revenue in 216. Of note, the business turned to profit in 4Q on the back of strong seasonality. Meanwhile, EV batteries remain exposed to risks related to China s regulations. The country s policies to strengthen the competitiveness of domestic industries is delaying Samsung SDI s foray into the Chinese market. Currently, the Chinese government bans subsidies to electric buses using nickelcobalt-manganese (NCM) batteries and certifies EV battery companies. NCM battery regulations are expected to be eased in 1H. However, it remains unclear whether Samsung SDI will be included in the fifth certification list. The fifth certification was originally scheduled for August-September of last year, but the government has still not released the results. Accordingly, we took a conservative approach to earnings estimates for Samsung SDI. If regulations ease and the company receives the certification, earnings could improve further from current estimates. Figure 123. ESS-use mid/large-sized battery revenue and OP margin trend (Wbn) 12 1 Revenue of large/mid-sized LIB for ESS (L) OP margin of large/mid-sized LIB for ESS (L) (%) Q13 1Q14 1Q15 1Q16 1Q17F -12 Figure 124. EV-use mid/large-sized battery revenue and OP margin trend (Wbn) 3 25 Revenue of large/mid-sized LIB for EV (L) OP margin of large/mid-sized LIB for EV (L) (%) Q13 1Q14 1Q15 1Q16 1Q17F -1 58

59 March 7, 217 Earnings outlook & valuation We forecast Samsung SDI s 217 full-year revenue at W6tr (+16.5% YoY) and operating profit at W1bn (turning to a profit YoY). For 217, we expect the smallbattery segment to turn around, backed by 1) its supply of polymer batteries to a key customer; 2) expansion of the ESS market; and 3) a pickup in ESS margins. While the electronic materials division should continue its steady growth, the firm should also generate roughly W77bn in equity method gains from its 15.2% stake in affiliate Samsung. Nevertheless, we do not expect the firm to stage a dramatic turnaround (from operating losses in 216) in 217, given lingering uncertainty over its flagship EV battery segment. For 1Q, we estimate revenue at W1.4tr (+7.1% QoQ, +8.% YoY) and operating loss at W32.3bn (remaining in the red QoQ, YoY). Revenue from small-sized batteries (e.g. polymer batteries) should continue to rise, in contrast to the downturn in ESS revenue amid seasonally weak demand. We maintain our Hold rating on Samsung SDI. We think expectations for an earnings turnaround (in 217) are already reflected in shares, while uncertainty over its flagship EV battery business remains undiminished. We are prepared to review our rating once uncertainty related to China s EV battery regulations is removed and the company wins the 5 th battery certification from the Chinese government. Table 21. Samsung SDI s valuation table (Wbn, W, x) EBITDA Target EV/EBITDA EV Remarks LIB ,164 5% discount to global peers EM (electronic materials) ,15 3% discount to global peers Total operating value (A) 2,269 Invested asset value (listed) 683 4% discount to market price invested asset value (nonlisted) 4,65 Total invested asset value (B) 4,748 Net debt (C) -1,439 EV (A)+(B)-(C) 8,456 No. of shares 68,765 Per-share value 122,971 Table 22. Consolidated earnings trends & outlook (Wbn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F Revenue 1,292 1,318 1,29 1,33 1,396 1,49 1,569 1,69 5,23 6,65 Batteries ,41 1,69 3,425 4,29 Small-sized (IT) ,488 2,833 Mid/large-sized (EV, ESS) ,196 Electronic materials ,773 2,35 OP Batteries Small-sized (IT) Mid/large-sized (EV, ESS) Electronic materials Other OP margin Batteries Electronic materials

60 March 7, 217 Table 23. Global peers valuation Market cap (Wbn, %, x) Revenue OP NP ROE P/E P/B EV/EBITDA 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F Samsung SDI 8,596 6,23 6, LG Chem 19,97 23,777 25,439 2,373 2,515 1,648 1, Panasonic 31,44 76,419 78,695 3,599 4,96 1,925 2, Sony 45,98 78,889 81,172 4,992 5,549 2,621 3, BYD 21,619 16,88 19,641 1,352 1, Simplo Technology 1,133 2,131 2, Avg Source: Bloomberg Figure 125. Global rechargeable battery makers relative share price trends Figure 126. Samsung SDI s OP consensus & share price (217F) (3/16=1) Samsung SDI 18 LG Chem Panasonic 16 Sony BYD 14 Simplo Tech (Wbn) OP consensus (L) Share price (R) (W) 145, 125, 15, 85, 65, 45, 4 3/16 6/16 9/16 12/16 3/17 25, 3/16 6/16 9/16 12/16 3/17 Figure 127. Global rechargeable battery makers P/B-ROE (217F) (P/B, x) Samsung SDI Sony Panasonic LG Chem BYD Simplo Tech (ROE, %) Figure 128. Global rechargeable battery players P/E-EPSG (217F) (P/E, x) BYD Panasonic LG Chem Simplo Tech Sony Samsung SDI (EPSG, %) , 6

61 March 7, 217 [Appendix] Company overview Founded in 197 as Samsung NEC, Samsung SDI was engaged mainly in the manufacture of vacuum tubes and black & white picture tubes during the 197s- 8s. While the firm derived up to 48% of its total revenue from the CRT business up until end-26, the plasma display panels (PDP) replaced CRT as its flagship business amid rapid advances in display technology. The firm decided to withdraw from the PDP business in 214. In July 214, Samsung SDI acquired electronics materials affiliate Cheil Industries. Following the sale of its chemicals unit to Lotte Chemicals in 215, the firm is currently engaged in the energy solution (e.g. small batteries and mid/large-sized batteries) and electronic materials businesses. As of 216, the firm derives 48% of its revenue from the small battery business; 18% from mid/large-sized batteries; and 38% from electronic materials. Key customers for its small-sized battery segment include global set makers, such as SEC and Apple, while a major customer for its mid/large-sized batteries is global automaker BMW. Major shareholders include SEC (21%) and the National Pension Service (8%), while key competitors include LG Chem, Japan-based Panasonic, and China-based BYD, ATL, and Lishen. The firm holds stakes in Samsung Group affiliates, including Samsung (15.2%), Samsung C&T (2.1%), Samsung Engineering (11.7%), and S1 Corp (11%). Table 24. Current status of group affiliates Affiliates Stake (%) Samsung 15.2 Samsung C&T 2.1 Samsung Engineering 11.7 S1 Corp 11 Samsung Heavy Industries.4 Hotel Shilla.1 Samsung Economic Research Institute 29.6 SD Flex 5 Source: Dart, Figure 129. Samsung SDI s shareholding structure Figure 13. Revenue breakdown by business (as of 216) SEC and affiliates 21% NPS 8% EM 34% Small-sized LIB 48% Other 71% Large/mid-sized LIB 18% 61

62 March 7, 217 Samsung SDI (64 KS/Hold) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue 7,569 5,21 6,65 6,792 Current Assets 4,774 3,939 3,8 3,975 Cost of Sales 6,186 4,45 5,153 5,681 Cash and Cash Equivalents 1, Gross Profit 1, ,111 AR & Other Receivables 1, SG&A Expenses 1,443 1, ,2 Inventories Operating Profit (Adj) Other Current Assets 1,681 1,714 1,66 1,584 Operating Profit Non-Current Assets 11,451 1,958 12,179 12,856 Non-Operating Profit Investments in Associates 5,173 5,444 6,493 7,3 Net Financial Income Property, Plant and Equipment 3,229 2,468 2,673 2,84 Net Gain from Inv in Associates Intangible Assets 1, Pretax Profit Total Assets 16,225 14,896 15,979 16,832 Income Tax Current Liabilities 3,21 2,228 2,624 2,841 Profit from Continuing Operations AP & Other Payables Profit from Discontinued Operations 1,9 Short-Term Financial Liabilities 1, Net Profit Other Current Liabilities 1,559 1,29 1,493 1,649 Controlling Interests Non-Current Liabilities 1,771 1,764 2,59 2,22 Non-Controlling Interests Long-Term Financial Liabilities Total Comprehensive Profit Other Non-Current Liabilities 1,69 1,251 1,546 1,77 Controlling Interests Total Liabilities 4,972 3,992 4,683 5,61 Non-Controlling Interests Controlling Interests 11,12 1,665 11,4 11,496 EBITDA Capital Stock FCF (Free Cash Flow) 155-2, Capital Surplus 5,31 5,31 5,31 5,31 EBITDA Margin (%) Retained Earnings 4,853 4,991 5,476 6,42 Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity 11,253 1,94 11,296 11,771 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities 881-1, P/E (x) Net Profit P/CF (x) Non-Cash Income and Expense P/B (x) Depreciation EV/EBITDA (x) Amortization EPS (W) 765 3,116 7,889 9,8 Others CFPS (W) 5,63 3,263 6,63 8,257 Chg in Working Capital 624-1, BPS (W) 156, , ,78 169,754 Chg in AR & Other Receivables DPS (W) 1, 1, 1, 1, Chg in Inventories Payout ratio (%) Chg in AP & Other Payables Dividend Yield (%) Income Tax Paid Revenue Growth (%) Cash Flows from Inv Activities 115 1, EBITDA Growth (%) Chg in PP&E Operating Profit Growth (%) ,1. Chg in Intangible Assets EPS Growth (%) Chg in Financial Assets 1,735-1, Accounts Receivable Turnover (x) Others ,452 Inventory Turnover (x) Cash Flows from Fin Activities Accounts Payable Turnover (x) Chg in Financial Liabilities ROA (%) Chg in Equity -1 ROE (%) Dividends Paid ROIC (%) Others Liability to Equity Ratio (%) Increase (Decrease) in Cash Current Ratio (%) Beginning Balance 628 1, Net Debt to Equity Ratio (%) Ending Balance 1, Interest Coverage Ratio (x) Source: Company data, estimates 62

63 March 7, 217 Duk San Neolux (21342 KQ) Flexible OLED lines coming onstream in 217 (Initiate) Buy Target Price (12M, W) 38, Share Price (3/6/17, W) 25,5 Expected Return 49% OP (17F, Wbn) 13 Consensus OP (17F, Wbn) 11 EPS Growth (17F, %) 14.6 Market EPS Growth (17F, %) 16.9 P/E (17F, x) 27.3 Market P/E (17F, x) 9.6 KOSDAQ 64.5 Market Cap (Wbn) 36 Shares Outstanding (mn) 12 Free Float (%) 38.7 Foreign Ownership (%) 16.6 Beta (12M) Week Low 19,5 52-Week High 35,5 (%) 1M 6M 12M Absolute Relative Duk San Neolux KOSDAQ OLED materials supplier Duk San Neolux, an OLED materials supplier, was established in December 214 via a spin-off of Duk San Hi-Metal s electroluminescence (EL) business. The company s key products include hole transport layers (HTLs) and red host materials. Major competitors include Doosan Corporation Electro-Materials (unlisted) in the HTL segment and Dow Chemical (US) in the red host market. Duk San Neolux s largest customer is Samsung. Investment point 1: Flexible OLED lines coming onstream in 217 Apple's OLED panel adoption has prompted Samsung and other global panel makers to invest in flexible OLED (since 216). As a result, related equipment vendors have outperformed the market in terms of earnings delivery and share prices. Notably, flexible OLED lines, in which panel makers made investments last year, are scheduled to start coming online in 217, which should create strong earnings momentum for Duk San Neolux. For 217, we expect the company to record revenue of W79.3bn (+87.5% YoY) and operating profit of W12.7bn (+224.5% YoY). Investment point 2: Positive effects of customer diversification Historically, the biggest risk factor facing the company has been price cuts. We estimate the OLED materials unit s OP margin plunged from around 4% in 211 to the 6% level in 215, due to steep price cuts resulting from 1% reliance on a single customer. Unlike in the previous capex cycle, however, we have been seeing a diverse group of global panel makers (hailing from China, Japan, Thailand, etc.) making aggressive advances into the flexible OLED market (starting in 216). Expansion of the potential customer base should lead to favorable changes in the operating environment, allowing Duk San Neolux to limit price cuts. Investment point 3: Foldable smartphones larger displays Foldable smartphone displays are generally two to three times larger than conventional displays. As such, increased penetration of foldable smartphones should lead to higher consumption of OLED materials. We project industry players will increasingly consider capacity additions to meet demand stemming from foldable devices. Of note, we estimate annual sales volume of 1mn 9 foldable devices would require flexible OLED capacity to increase to more than 1, sheets/month. We expect additional capex to drive up demand for OLED materials. Initiate coverage with Buy and target price of W38, We initiate our coverage on Duk San Neolux with a Buy rating and target price of W38,. Our target price is based on a 12-month-forward EPS and a 4% discount to the multiple of UDC (a major global peer). FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) OP (Wbn) OP margin (%) NP (Wbn) EPS (W) ,536 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 63

64 March 7, 217 Investment point 1: Flexible OLED lines coming onstream in 217 In 216, OLED equipment vendors outperformed the market in terms of earnings delivery and share prices on a sharp increase in OLED-related investments, driven by OLED adoption by Apple iphones. We think OLED materials suppliers deserve attention, as flexible OLED lines, in which panel makers made investments last year, are slated to come online in 217, We forecast Duk San Neolux s 217 full-year revenue at W79.3bn (+87.5% YoY) and operating profit at W12.7bn (+224.5% YoY). Operating profit, in particular, should reach an all-time high, thanks to: 1) stronger demand for OLED materials on a significant rise in OLED capacity utilization; and 2) fresh revenue from new products (other than HTLs). In 217, the company should generate additional revenue from its likely supply of red host materials (to SEC) and HTLs (to Apple). Indeed, Duk San Neolux has been designated as a supplier of red host materials for use in the Galaxy S8 (slated for release this year), while its HTL production line is scheduled to start operation in May. Notably, red host materials should make significant contributions to company-wide revenue and profit in 217, with the revenue proportion of the materials likely to rise sharply from 2% in 216 to 44% in 217. Figure 131. Scheduled launches of Samsung s flexible OLED production lines Figure 132. Revenue trends by product (Wbn) 35 3 HTL Red host Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F 1Q18F 2Q18F 3Q18F 4Q18F 64

65 March 7, 217 Investment point 2: Positive effects of customer diversification Historically, the biggest risk factor facing Duk San Neolux has been price cuts. The prices of HTL materials have recently declined sharply vs. 211 (when massive investments were made in the A2 line), leading to marked margin erosion for the company. We estimate the OLED materials unit s OP margin plunged from around 4% in 211 to the 6% level in 215. Unlike in the previous capex cycle, however, we have been seeing a diverse group of global panel makers (hailing from China, Japan, Thailand, etc.) making aggressive advances into the flexible OLED market (starting in 216). Expansion of the potential customer base should lead to favorable changes in the operating environment, allowing Duk San Neolux to limit price cuts. Merck, which owns the core technology for liquid crystals (a key LCD material), saw its LCD-related revenue and margins rising in line with a pickup in LCD TV penetration. During that period, Merck was able to maintain strong top-line and bottom-line growth, thanks mainly to high technological entry barriers and fasterthan-expected LCD penetration. Sharp growth in LCD demand amid limited growth in key LCD materials supply helped benefit LCD material suppliers. In the liquid crystals market, Merck continues to form a duopoly with Japan-based Chisso. Apple s entry into the flexible smartphone market has been accelerating the small/mid-sized display market s shift to OLED. While LGD and Chinese panel makers have been making aggressive investments in small/mid-sized OLED, the number of key OLED materials suppliers has remained limited, which we think hints at marginal downside in prices of OLED materials in the current (second) capex cycle. Figure 133. Duk San Neolux s revenue and OP margin trends (based on EL division s figures for pre-215 years) (Wbn) 1 Revenue (L) OP margin (R) (%) F Figure 134. Merck s liquid crystal revenue vs. LCD TV penetration (EURmn) 1, Liquid crystal revenue (L) LCD TV penetration (R) 51 (%)

66 March 7, 217 Investment point 3: Foldable smartphones larger displays Foldable smartphone displays are usually two to three times larger than conventional displays. As such, increased penetration of foldable smartphones should lead to higher consumption of OLED materials. We project industry players will increasingly consider capacity additions to meet demand stemming from foldable devices. Notably, we estimate annual sales volume of 1mn 9. foldable devices would require flexible OLED capacity to increase to more than 1, sheets/month. We expect additional capex to drive up demand for OLED materials. Figure 135. No. of panels capable of being produced per mother glass (units) 6 Number of producible panel units per 6G mother glass (inch) Figure 136. Required capacity to meet foldable device sales target of 1mn units (' sheets/month) 14 Flexible OLED capacity for production of 1mn foldable devices (inch) Table 25. Required capacity to meet foldable device sales target of 1mn units Inch No. of panels produced per mother glass (sheets) Monthly output based on 6G 15K ( sheets) Annual output based on 6G 15K ( sheets) Required capacity to meet sales target of 1mn units ( sheets/month) ,695 92, ,95 59, ,96 47, ,75 44, ,35 16, ,26 15, ,17 14,

67 March 7, 217 Earnings outlook & valuation We initiate our coverage on Duk San Neolux with a Buy rating and target price of W38,. Our target price is based on a 12-month-forward EPS and a 4% discount to the multiple of UDC (a major global peer). We think the discount is justified, in light of UDC s sizable revenue portion of royalty and license fees. UDC receives royalty and license fees from panel makers, as it holds patents on key OLED material-making technologies. Of note, Duk San has seen its valuation gap with UDC widen following recent share price corrections of domestic OLED panel makers. However, we expect the valuation gap to narrow on an expected pickup in the firm s 1Q earnings, as earnings of OLED materials suppliers should not be affected by delayed OLED investments by Chinese panel makers. Table 26. Valuation table Remarks 12M forward EPS (W) 1,36 Current P/E (x) % discount to UDC s 12M forward P/E Target P/E (x) 36.8 Discount is due to UDC s sizable royalty fee revenue TP (W) 38, Current price (W) 25,55 Upside (%) 49. Figure month forward P/E trends: Duk San Neolux vs. UDC Figure month forward P/B trends: Duk San Neolux vs. UDC (x) 6 5 Duksan Neolux's 12MF P/E UDC's 12MF P/E (x) 8 6 Duksan Neolux's 12MF P/B UDC's 12MF P/B Increase in valuation gap 2.6x Average 1.6x 2 Average 1.3x 1 11/15 2/16 5/16 8/16 11/16 2/17 Increase in valuation gap 1.9x 2 11/15 2/16 5/16 8/16 11/16 2/17 Table 27. Duk San Neolux s earnings trends & outlook (Wmn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F Revenue 13,2 9,93 8,9 1,3 14,47 19,848 22,265 22,842 4,32 42,33 79,362 HTL 11,35 8,28 6,953 7,676 8,92 1,324 11,866 13,184 36,22 34,6 44,294 Red Host 1,85 1,92 1,947 2,624 5,488 9,524 1,399 9,658 4,1 8,324 35,69 (%) HTL Red Host OP 1, ,888 2,666 4,364 3,821 2,44 3,925 12,74 Pre-tax profit 1, ,766 2,8 2,786 4,484 3,941 2,74 4,496 13,22 Net profit 1, ,943 1,77 2,368 3,812 3,35 2,16 4,673 11,237 OP margin Pre-tax margin Net margin Growth (QoQ/YoY, %) Revenue OP Pre-tax profit Net profit estimates 67

68 March 7, 217 [Appendix] Company overview Duk San Neolux, an OLED materials supplier, was established in December 214 via a spin-off of Duk San Hi-Metal s EL business. The company has steadily solidified its presences in the organic OLED materials market since its acquisition of an OLED materials maker in August 29. The company s key products include HTLs and red host materials. With sales of HTLs increasing sharply thanks to the launches of the Galaxy S and Note series, the company posted the highest revenue in its history in In 213, however, both revenue and profitability declined due to 1) the entry of a competitor in the HTL market, 2) the delay to product diversification to include OLED materials, 3) a customer s delayed OLED investments, and 4) sluggishness in the smartphone market. Starting in 217, we expect the company supply red host materials to SEC, which has changed smartphone materials for the Galaxy S8. In addition, HTL sales will also likely expand on the adoption of OLED panels by Apple. In 218, we expect the company to diversify its customer base, given that Chinese, Taiwanese, and Japanese makers should start their OLED lines. The company s shareholding structure is composed of Duk San Hi-Metal (33%), CEO and affiliated persons (22%), Fidelity (9%), NPS (7%), and Korea Investment Management (6%). We think the company has only a small number free float shares. We believe corporate governance issues were resolved thanks to the spinoff in 215. Figure 139. Duk San Neolux s shareholding structure Largest shareholder 18% 22% Duksan Holdings 35% Duksan 33.33% Himetal Duksan Neolux 7% 3.3% 4% 7% Duksan UMT ACN Daesung Newtech Duksan SG Figure 14. Duk San Neolux s shareholding structure (as of 3Q16) Figure 141. OLED structure Other 22% Duksan Himetal 33% Korea Investment Mgmt. 6% Fidelity 9% NPS 7% Duksan Holdings 1% Affiliates 22% Source: Company data, Source: Company data 68

69 March 7, 217 Duk San Neolux (21342 KQ/Buy/TP: W38,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue Current Assets Cost of Sales Cash and Cash Equivalents Gross Profit AR & Other Receivables SG&A Expenses Inventories Operating Profit (Adj) Other Current Assets Operating Profit Non-Current Assets Non-Operating Profit 1 Investments in Associates Net Financial Income Property, Plant and Equipment Net Gain from Inv in Associates Intangible Assets Pretax Profit Total Assets Income Tax Current Liabilities Profit from Continuing Operations AP & Other Payables Profit from Discontinued Operations Short-Term Financial Liabilities Net Profit Other Current Liabilities Controlling Interests Non-Current Liabilities Non-Controlling Interests Long-Term Financial Liabilities Total Comprehensive Profit Other Non-Current Liabilities Controlling Interests Total Liabilities Non-Controlling Interests Controlling Interests EBITDA Capital Stock FCF (Free Cash Flow) Capital Surplus EBITDA Margin (%) Retained Earnings Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities P/E (x) Net Profit P/CF (x) Non-Cash Income and Expense P/B (x) Depreciation EV/EBITDA (x) Amortization EPS (W) ,536 Others CFPS (W) ,312 2,46 Chg in Working Capital BPS (W) 8,695 9,2 9,956 11,491 Chg in AR & Other Receivables -3-1 DPS (W) Chg in Inventories Payout ratio (%).... Chg in AP & Other Payables Dividend Yield (%).... Income Tax Paid -2-4 Revenue Growth (%) Cash Flows from Inv Activities EBITDA Growth (%) Chg in PP&E -3-1 Operating Profit Growth (%) Chg in Intangible Assets EPS Growth (%) Chg in Financial Assets Accounts Receivable Turnover (x) Others -1 Inventory Turnover (x) Cash Flows from Fin Activities 3-1 Accounts Payable Turnover (x) Chg in Financial Liabilities 2 ROA (%) Chg in Equity ROE (%) Dividends Paid ROIC (%) Others 3-3 Liability to Equity Ratio (%) Increase (Decrease) in Cash Current Ratio (%) Beginning Balance Net Debt to Equity Ratio (%) Ending Balance Interest Coverage Ratio (x) Source: Company data, estimates 69

70 March 7, 217 SKC Kolon PI (17892 KQ) Seeking to enter the foldable display market PI film maker (Initiate) Buy Target Price (12M, W) 18, Share Price (3/6/17, W) 14,65 Expected Return 23% OP (17F, Wbn) 39 Consensus OP (17F, Wbn) 39 EPS Growth (17F, %) 25.3 Market EPS Growth (17F, %) 16.9 P/E (17F, x) 16.5 Market P/E (17F, x) 9.6 KOSDAQ 64.5 Market Cap (Wbn) 43 Shares Outstanding (mn) 29 Free Float (%) 44.8 Foreign Ownership (%) 4.2 Beta (12M) Week Low 9,4 52-Week High 15,8 (%) 1M 6M 12M Absolute Relative SKC Kolon PI, Inc. KOSDAQ SKC Kolon PI (SKPI) was founded in 28 via a merger between the spun-off PI film divisions of Kolon Industries and SKC. PI films are an advanced plastic material with superior thermal properties (ranging from -269 to 4 ). SKPI s PI film products are categorized into FPCB-use, heat-resistant-sheet-use, and general-industrial-use PI films. We expect the company s PI film products to be applied to foldable displays going forward. Investment point 1: New materials to be adopted in foldable displays In the shift from rigid OLED to foldable displays, 1) the cover glass will be replaced by colorless PI (CPI); 2) PI varnish will be used in place of TFT substrates; and 3) the base film will also be changed. We believe SKPI is able to benefit from these three changes in the medium to long term. In the short term, SKPI is likely to enter the PI varnish market, which is currently monopolized by SU Materials (SUM), a joint venture between Samsung Mobile and Ube Industries. The need to diversify PI varnish suppliers is increasing amid flexible OLED market expansion. We believe PI film makers, including SKPI, are currently testing their own PI varnish products. Investment point 2: Expansion of the heat-resistant sheet market The Galaxy Note 7 battery issue brought keen attention to heat-resistant features. The thickness and bezel of smartphones are becoming thinner for the sake of sleek design, while specifications are becoming more sophisticated. In particular, demand for heat-resistant sheets will likely continue to climb, aided by Chinese smartphone makers adoption of OLED panels, high-performance CPUs/GPUs, and metal cases. Currently, we believe SKPI controls 8% of the Chinese heat-resistantsheet-use PI film market. Initiate coverage with Buy and target price of W18, We initiate our coverage on SKPI with a Buy rating and target price of W18,. We derived our target price by applying a 3% premium to the average P/E of global PI film makers, as: 1) the company specializes in the PI film business, unlike its competitors; and 2) it boasts an oligopolistic presence in the domestic smartphone market. We believe the stock could be re-rated in the event the company enters the flexible display materials market. For PI varnish supplier diversification to start in 218, additional suppliers should be selected by 1H17 at the latest, as it takes 8 to 1 months to build production lines. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) OP (Wbn) OP margin (%) NP (Wbn) EPS (W) ,12 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 7

71 March 7, 217 Investment point 1: New materials to be adopted in foldable displays <Figure 144> shows the current foldable display production process. In the shift from rigid OLED to foldable displays, 1) the cover glass will be replaced by colorless PI (CPI); 2) PI varnish will be used in place of TFT substrates; and 3) the base film will also be changed. We believe SKPI is able to benefit from these three changes in the medium to long term. In the short term, SKPI is likely to enter the PI varnish market. In rigid OLEDs, glass TFT substrates are used. For curved OLEDs, PI varnish, a solution of polyimide precursor (polyamic acid) is used to make flexible substrates via the PI curing process. The PI varnish market is currently monopolized by SUM, a joint venture between Samsung Mobile and Ube Industries. The need to diversify PI varnish suppliers is increasing amid flexible OLED market expansion. We believe PI film makers, including SKPI, are currently testing their own PI varnish products. Figure 142. Mobile-use PI varnish shipment forecast (tonnes) 1, 8 Bendable Flat Curved Foldable F 18F 19F 2F 21F 22F 23F Source: HIS, Figure 143. SUM s earnings trend (Wmn) 6, 5, 4, 3, 2, 1, -1, Revenue (L) Net profit (L) Net margin (R) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 (%) Source: Dart, 71

72 March 7, 217 In the medium to long term, we expect SKPI to expand into the CPI and base film markets. CPI is an essential material for foldable displays. Currently, glass is used for the cover glass in most curved OLED smartphone models, but foldable displays require a transparent cover that is more flexible than glass. CPI removes the hygroscopic property and color of conventional PI films, while maintaining superior heat-resistant and mechanical properties. Kolon Industries and Samsung are currently developing CPI and building factories to start production in February 218. In addition, given that SKC is also developing CPI, we expect SKPI to commercially produce CPI as an OEM for SKC. Mitsubishi Chemical is also engaged in CPI development. For base films, PET films are currently used in curved OLEDs. In foldable displays, PI films are likely to replace PET films to increase flexibility, benefitting exiting PI film makers. We did not reflect new materials related to foldable displays in our earnings estimates due to their high uncertainties. However, we will reflect them when SEC unveils the prototype of a foldable device and considers capex on commercial production lines. Figure 144. New materials used in foldable displays Rigid OLED Curved OLED Foldable OLED 1) Kolon Industries 2) SKC (SKC Kolon PI) 1) SUM (monopoly) 2) SKC Kolon PI, etc. PI film maker 72

73 March 7, 217 Investment point 2: Expansion of the heat-resistant sheet market The Galaxy Note 7 battery issue brought keen attention to heat-resistant features. Video content consumption on smartphones is increasing, while the amount of data transmission is expanding due to the introduction of LTE technology, thus generating more heat on mobile devices. Meanwhile, the thickness and bezel of smartphones are becoming thinner for the sake of sleek design. In the past, heat-resistant sheets were made mainly of silver, copper, and aluminum. Recently, graphite, which has twice the heat conductivity of these materials, is commonly used. SKPI produces PI films that are used to produce heat-resistant graphite sheets. We believe the company controls more than 9% of the Chinese market and 6-7% of the global graphite sheet market. We expect the company s heat-resistant sheet sales to expand steadily due to increasingly sophisticated Chinese smartphone models. Demand for heat-resistant sheets will likely continue to climb, aided by Chinese smartphone makers adoption of OLED panels, high-performance CPUs/GPUs, and metal cases. Figure 145. Chinese smartphone shipments breakdown by memory capacity (%) 1 256GB+ 128GB<256GB 64GB<128GB 32GB<64GB 16GB<32GB 8GB<16GB 4GB<8GB 1GB<4GB Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 Figure 146. Galaxy S7 s heat-resistance system Figure 147. Revenue contribution of heat-resistant-sheet-use PI films is on the rise 1 FPCB G/S Industrial Q13 1Q14 1Q15 1Q16 1Q17F 73

74 March 7, 217 Earnings forecast and valuation In 217, we expect SKPI to post solid revenue of W172bn (+12.4% YoY) and operating profit of W38.7bn (+19.9% YoY) thanks to the operation of a new line at end-3q16. We did not reflect new materials related to foldable display in our earnings estimates due to their high uncertainties. For 1Q17, we forecast revenue at W39bn (+1.7% QoQ, +6.% YoY) and operating profit at W8.4bn (-3.4% QoQ, +11.4% YoY). The onset of low-demand season for heat-resistant sheet-use PI films will likely be offset by the beginning of highdemand season for FPCB-use PI films. Initiate coverage with Buy and target price of W18, We initiate our coverage on SKPI with a Buy rating and target price of W18,. We derived our target price by applying a 3% premium to the average P/E of global PI film makers, as: 1) the company specializes in the PI film business, unlike its competitors; and 2) it boasts an oligopolistic presence in the domestic smartphone market. We believe the stock could be re-rated in the event the company enters the flexible display materials market. For PI varnish supplier diversification to start in 218, additional suppliers should be selected by 1H17 at the latest, as it takes eight to 1 months to build production lines. Table 28. SKPI s valuation table 12M forward EPS (W) Current P/E (x) 15.2 Fair P/E (x) 19.5 Target price (W) 18, Current price (W) 14,65 Upside (%) 22.9 Notes - Applied a 3% premium to the average P/E of global peers in light of the company s expertise and dominant position. - To be re-rated in the event the company enters the flexible display materials market. Table 29. Earnings forecasts for SKPI (Wbn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F Revenue FPCB-use PI Heat-resistant sheet-use PI f General-industrial-use PI Other Revenue contribution FPCB-use PI Heat-resistant sheet-use PI General-industrial-use PI Other Operating profit Pretax profit Net profit OP margin Pretax margin Net margin Growth (QoQ/YoY, %) Revenue FPCB-use PI Heat-resistant sheet-use PI General-industrial-use PI Other Operating profit Pretax profit TTB Net profit TTB

75 March 7, 217 [Appendix] Company overview SKPI was founded in 28 via a merger between the spun-off PI film divisions of Kolon Industries and SKC. PI films are an advanced plastic material with superior thermal properties (ranging from -269 ~ 4 ). Initially used in aerospace industries, PI films are now used in a wide range of applications. SKPI s PI film products are categorized into FPCB-use, heat-resistant-sheet-use, and general-industrial-use films. 1) In FPCB, PI films serve as both an electricity-conductive substrate and an insulator. SKPI supplies PI films to producers of FCCL (a main component of FPCB), such as Innox. 2) The company s heat-resistant-sheet-use films are mainly used to make artificial graphite sheet films. PI films become graphite sheets after they are burned at a high temperature and undergo graphitization. The business has grown full-swing since ) General-industrial-use films are used for electricity insulation, aerospace, and semiconductor/battery production. Of note, insulation PI films prevent electricity leakage from power generators or transformers. When applied in semiconductor and battery processes, the film serves as an insulting tape. Figure 148. SKPI s ownership breakdown (3Q16) Figure 149. PI film market breakdown (216) Other 45% SKC 27% Other 39% SKPI 23% Kaneka 2% Employee stock ownership association 1% Kolon Industries 27% Dupont 8% TDC 1% Source: SKPI, Source: SKPI, Figure revenue breakdown (216) Figure 151. Competitors in each product category Industrial 17% G/S 29% FPCB 54% Source: SKPI, Source: SKPI, 75

76 March 7, 217 SKC Kolon PI (17892 KQ/Buy/TP: W18,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue Current Assets Cost of Sales Cash and Cash Equivalents Gross Profit AR & Other Receivables SG&A Expenses Inventories Operating Profit (Adj) Other Current Assets 1 1 Operating Profit Non-Current Assets Non-Operating Profit Investments in Associates Net Financial Income Property, Plant and Equipment Net Gain from Inv in Associates Intangible Assets Pretax Profit Total Assets Income Tax Current Liabilities Profit from Continuing Operations AP & Other Payables Profit from Discontinued Operations Short-Term Financial Liabilities Net Profit Other Current Liabilities Controlling Interests Non-Current Liabilities Non-Controlling Interests Long-Term Financial Liabilities Total Comprehensive Profit Other Non-Current Liabilities Controlling Interests Total Liabilities Non-Controlling Interests Controlling Interests EBITDA Capital Stock FCF (Free Cash Flow) Capital Surplus EBITDA Margin (%) Retained Earnings Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities P/E (x) Net Profit P/CF (x) Non-Cash Income and Expense P/B (x) Depreciation EV/EBITDA (x) Amortization EPS (W) ,12 Others CFPS (W) 1,212 1,455 1,596 1,852 Chg in Working Capital BPS (W) 7,171 7,771 8,55 9,543 Chg in AR & Other Receivables DPS (W) Chg in Inventories Payout ratio (%) Chg in AP & Other Payables Dividend Yield (%) Income Tax Paid Revenue Growth (%) Cash Flows from Inv Activities EBITDA Growth (%) Chg in PP&E Operating Profit Growth (%) Chg in Intangible Assets EPS Growth (%) Chg in Financial Assets Accounts Receivable Turnover (x) Others -1 Inventory Turnover (x) Cash Flows from Fin Activities Accounts Payable Turnover (x) Chg in Financial Liabilities 7 16 ROA (%) Chg in Equity ROE (%) Dividends Paid ROIC (%) Others Liability to Equity Ratio (%) Increase (Decrease) in Cash Current Ratio (%) Beginning Balance Net Debt to Equity Ratio (%) Ending Balance Interest Coverage Ratio (x) Source: Company data, estimates 76

77 March 7, 217 Advanced Process Systems (5462 KQ) Many customers, but no competitor ELA and LLO equipment producer Not Rated Target Price (12M, W) - Share Price (3/6/17, W) 27,85 Expected Return - OP (17F, Wbn) 97 Consensus OP (17F, Wbn) 88 EPS Growth (17F, %) Market EPS Growth (17F, %) 16.9 P/E (17F, x) 1.3 Market P/E (17F, x) 9.6 KOSDAQ 64.5 Market Cap (Wbn) 713 Shares Outstanding (mn) 29 Free Float (%) 81.2 Foreign Ownership (%) 16.9 Beta (12M) Week Low 15,45 52-Week High 29,85 (%) 1M 6M 12M Absolute Relative AP Systems KOSDAQ Established in 1994, Advanced Process Systems (AP Systems) is a display and semiconductor equipment producer. Its businesses are divided into: 1) OLED, 2) LCD, and 3) semiconductor equipment. OLED equipment, including excimer laser annealing (ELA) and laser lift-off (LLO), accounts for over 9% of total revenue. Investment point 1: Many customers, but no competitor In our view, there should be no real competition for AP Systems in the OLED equipment market in the foreseeable future. It is the only company with experience supplying ELA and LLO equipment to 6G flexible OLED lines. Although JSW (a Japanese ELA equipment maker) and EO Technics (a domestic LLO equipment manufacturer) are producing OLED equipment, the company should have the upper hand in entering the Chinese market thanks to its record of supplying to SEC. Currently, the company is expected to supply 9% of OLED equipment (ELA and LLO) needs at Chinese panel makers. Meanwhile, the customer base is diversifying, as Chinese panel makers are ramping up investments in 6G OLED lines. Even our highly conservative estimate puts 6G investments by overseas display makers (Japan, Taiwan, and China) at a lofty 13, sheets per month for 217. Total new investments (domestic + overseas) are forecast at 175, sheets per month this year, which should translate into new OLED equipment orders of around W1tr for AP Systems. Investment point 2: Encapsulation equipment for foldable displays AP Systems is projected to expand its presence in encapsulation equipment once display makers begin to ramp up foldable OLED production capacity. (Conversion to foldable OLED lines should require more sophisticated encapsulation equipment.) Assuming an annual sales volume target of 1mn 9 foldable devices, flexible OLED capacity should increase to over 1, sheets/month. SEC and Apple together sell around 3mn premium smartphones a year, and thus, investments in flexible OLED are likely to continue over the medium to long term. Investment point 3: Streamlining business through spin-off In October 216, AP Systems announced its decision to separate the company into APS Holdings (surviving) and AP Systems (newly established). Post-spinoff enterprise value is likely to remain more or less the same, given that the display equipment businesses will remain intact under the newly established entity. We plan to provide a detailed analysis of the post-spinoff business and target price in follow-up reports. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) ,1 1,28 OP (Wbn) OP margin (%) NP (Wbn) EPS (W) ,25 2,692 2,751 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 77

78 March 7, 217 Investment point 1: Many customers, but no competitor AP Systems major products are ELA and LLO equipment, both of which are used in OLED processes. The company has been an exclusive ELA equipment provider for Samsung since Samsung s first OLED investment (4.5G lines). LLO equipment is used only for flexible OLED processes. The company s LLO equipment sales began with Samsung s flexible display line investments. In our view, AP Systems should see no real competition in the OLED equipment market for the foreseeable future. Although JSW of Japan also produces ELA equipment, its products are believed to be more suited for LCD production, whereas AP Systems products are specialized for OLED. The company should have the upper hand in entering the Chinese market thanks to its record of supplying to SEC. Currently, the company is expected to supply 9% of ELA equipment needs at Chinese panel makers. LLO equipment applies laser to separate the carrier glass in order to make panels more flexible. The major competitor is EO Technics, which provides LLO equipment to LGD s small/mid-sized OLED lines. However, AP Systems is the only company with a record of supplying equipment for 6G flexible OLED lines. For LLO equipment, the company is also expected to enjoy a competitive advantage over rivals in the Chinese market. Figure 152. AP Systems revenue and OP margin trend by business (Wbn) LCD equipment Semiconductor equipment 3 OLED equipment Subsidiary & other OP margin (R) 25 2 (%) Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17F 3Q17F -2 Source: AP Systems, Figure 153. ELA process Figure 154. LLO process Source: AP Systems, Source: AP Systems, 78

79 March 7, 217 Table 3. AP Systems sales contracts (disclosed) Meanwhile, the customer base is diversifying, as Chinese panel makers are ramping up investments in 6G OLED lines. We do not expect investments in mass production lines to begin anytime soon in China, given the lack of technology. Nevertheless, Chinese panel makers are anticipated to continue to make sizeable investments, helped by government subsidies, and in order to catch up with Samsung. Even our highly conservative estimate puts 6G investments by overseas display makers (Japan, Taiwan, and China) at a lofty 13, sheets per month for 217. For 217, major Korean panel makers are projected to make OLED investments with a monthly capacity of 45, sheets (15, sheets at A3, plus 3, sheets at L7-1). And OLED investments by overseas panel makers are estimated at 13, sheets/month, as mentioned above. Given this, we expect AP Systems to record new OLED equipment orders of around W1tr for the full year, even factoring in potential increased competition and investment delays. As overseas revenue expands, the firm s export revenue share is likely to soar from 12% in 216 to 4% in 217. Sales amount (Wbn) Sales item Customer Date of disclosure Date of order End of contract 48 equipment Samsung 2/29/16 12/26/16 12/3/16 47 OLED equipment Xiamen Tianma 6/28/16 6/27/16 8/1/17 13 equipment Samsung 8/1/16 1/11/16 1/31/17 - Equipment - 1/11/16 1/1/16 1/15/17 3 equipment Samsung 12/1/16 9/27/16 2/1/17 AP Systems 58 Equipment - 12/6/16 12/5/16 5/31/17 13 Equipment - 12/14/16 12/13/16 5/31/17 - Equipment - 12/22/16 4/5/16 3/31/17 - Equipment - 12/22/16 5/1/16 7/3/17 3 Equipment - 1/1/17 1/9/17 5/31/17 6 OLED equipment Yungu (Gu`an) 1/25/17 1/25/17 7/15/ Equipment - 2/24/17 2/23/17 1/31/17 Source: Dart, Figure 155. OLED investment schedules of overseas panel makers ( : Order Equipment, : Install, : Production) Source: IHS, 79

80 March 7, 217 Investment point 2: Encapsulation equipment for foldable displays Unlike LCDs, OLED requires encapsulation to protect organic materials from moisture and oxygen. Currently, AP Systems encapsulation equipment is used only in Samsung s rigid OLED lines. (Samsung s flexible OLED lines use encapsulation equipment built by Applied Materials and Kateeva of the US.) However, AP Systems is projected to expand its presence in encapsulation equipment once display makers begin to ramp up foldable OLED production capacity. (Conversion to foldable OLED lines should require more sophisticated encapsulation equipment.) Over the medium to long term, AP Systems is anticipated to diversify its encapsulation equipment lineup as the foldable display market grows in size. Assuming that mass production of foldable devices begins in 219, orders for frontend process equipment and deposition equipment should be placed around one and a half years earlier. As such, panel makers are likely to consider additional capex for foldable display lines at end-217, in our view. Assuming an annual sales volume target of 1mn 9 foldable devices, flexible OLED capacity should increase to over 1, sheets/month. SEC and Apple together sell around 3mn premium smartphones a year, and thus, investments in flexible OLED are likely to continue over the medium to long term. Figure 156. Required capacity estimation based on sales volume target (' sheets/month) 14 Flexible OLED capacity for production of 1mn foldable devices (inch) Figure 157. OLED encapsulation equipment of AP Systems Source: Company data, 8

81 March 7, 217 Investment point 3: Streamlining business through spin-off In October 216, AP Systems announced its decision to separate the company into APS Holdings (surviving) and AP Systems (newly established). The spin-off ratio will be.47:.53 (each APS Holdings shareholder will receive.47 shares of AP Systems for every.53 shares of APS Holdings held). Post-spinoff enterprise value is likely to remain more or less the same, given that the semiconductor and display equipment businesses will remain intact under the newly established entity. However, market cap tends to increase following a spinoff, possibly due to greater investor expectations for management transparency, efficient allocation of resources, and business specialization. We plan to provide a detailed analysis of the post-spinoff business and target price in follow-up reports. Table 31. Spin-off schedule Event Date BOD resolution 1/14216 Submission of securities registration statement 12/15/216 Shareholders meeting (approval of spinoff plans) 1/26/217 Spinoff 3/1/217 Submission of old stock certificates 1/27/217 2/27/217 Stock trading suspension 2/24/217 4/6/217 Modified listing 4/7/217 Re-listing 4/7/217 Source: Dart, Figure 158. Post-spinoff corporate governance (forecast) Source: Dart, Figure 159. Market cap of Duk San Hi-Metal (before/after spinoff) Figure 16. Market cap of Wonik IPS (before/after spinoff) (Wbn) 8 6 Duksan Himetal Duksan Neolux (Wbn) 1,8 1,5 1,2 Wonik Holdings Wonik IPS /14 4/15 1/15 4/16 1/16 Source: WISEfn, 1/14 4/15 1/15 4/16 1/16 Source: WISEfn, 81

82 March 7, 217 Earnings outlook and valuation For 217, AP Systems is expected to record revenue of W1.1tr (+8.4% YoY) and an operating profit of W97.1bn (+21.4% YoY). Orders from major domestic customers are projected at 45, sheets/month, down from the 216 level. However, orders from overseas (including China) panel makers related to investments in small/mid-sized OLED lines will likely offset domestic order declines. In forecasting earnings for 217, we assumed overseas orders at 15, sheets/month. Meanwhile, orders totaling W4bn are estimated to have been deferred from last year. For 1Q17, we expect revenue of W25bn (+464.4% YoY) and operating profit of W26.4bn (swinging to a profit YoY). In 4Q16, the company recognized revenue for its OLED laminating equipment supplies to SDC, which provided a lift to overall topline growth. We estimate order backlog for the equipment is around W2bn, most of which will likely be recorded in 1H17. We plan to present our investment rating and target price after the company s split. The company was officially split on March 1 st and the newly established entity will be relisted on April 7 th. Table 32. Earnings trends and forecasts (Wbn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F Revenue LCD equipment Semi equipment OLED equipment Subsidiaries and other % of revenue LCD equipment Semi equipment OLED equipment Subsidiaries and other Operating profit Pretax profit Net profit OP margin Pretax margin Net margin Growth (QoQ/YoY, %) Revenue LCD equipment Semi equipment OLED equipment Subsidiaries and other Operating profit Pretax profit Net profit estimates 82

83 March 7, 217 [Appendix] Company overview Established in 1994, AP Systems is a display and semiconductor equipment producer. The company s businesses are largely divided into: 1) OLED, 2) LCD, and 3) semiconductor equipment. OLED equipment, including excimer laser annealing (ELA) and laser lift-off (LLO), accounts for over 9% of total revenue. 1) ELA equipment: ELA is a process designed to convert amorphous silicon (a-si) to polycrystalline silicon (p-si) using lasers. p-si is mostly used in the manufacturing of mobile displays because of its higher electron mobility compared to a-si (mainly used in LCD TVs). ELA is applied to both LCD and OLED processes, and AP System has been the exclusive ELA supplier to Samsung since its first OLED investment (4.5G line) in ) LLO equipment: LLO, which is only used in the production of flexible OLEDs as a final step in the front-end process, applies laser to separate the carrier glass in order to make the panels more flexible. AP System s medium- and long-term growth driver is its encapsulation equipment for foldable displays. We think the biggest change in the front-end process for foldable displays will be in encapsulation. We believe testing is currently underway and think this area warrants attention once talks of foldable display mass production begin. Figure 161. Revenue breakdown (216) Figure 162. ELA equipment Subsidiary & other 8% Semiconductor equipment 3% OLED equipment 88% Source: Company data, Source: Company data, Figure 163. LLO equipment Figure 164. Encapsulation equipment Source: Company data, Source: Company data, 83

84 March 7, 217 Advanced Process Systems (5462 KQ/Not Rated) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue ,1 1,28 Current Assets Cost of Sales Cash and Cash Equivalents Gross Profit AR & Other Receivables SG&A Expenses Inventories Operating Profit (Adj) Other Current Assets Operating Profit Non-Current Assets Non-Operating Profit Investments in Associates Net Financial Income -3 Property, Plant and Equipment Net Gain from Inv in Associates Intangible Assets Pretax Profit Total Assets Income Tax Current Liabilities Profit from Continuing Operations AP & Other Payables Profit from Discontinued Operations Short-Term Financial Liabilities Net Profit Other Current Liabilities Controlling Interests Non-Current Liabilities Non-Controlling Interests Long-Term Financial Liabilities Total Comprehensive Profit Other Non-Current Liabilities Controlling Interests Total Liabilities Non-Controlling Interests Controlling Interests EBITDA Capital Stock FCF (Free Cash Flow) Capital Surplus EBITDA Margin (%) Retained Earnings Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities P/E (x) Net Profit P/CF (x) Non-Cash Income and Expense P/B (x) Depreciation EV/EBITDA (x) Amortization EPS (W) 368 1,25 2,692 2,751 Others CFPS (W) 938 2,192 3,973 4,69 Chg in Working Capital BPS (W) 5,512 7,886 1,579 13,33 Chg in AR & Other Receivables DPS (W) Chg in Inventories Payout ratio (%).... Chg in AP & Other Payables Dividend Yield (%).... Income Tax Paid Revenue Growth (%) Cash Flows from Inv Activities EBITDA Growth (%) Chg in PP&E Operating Profit Growth (%) Chg in Intangible Assets -5-3 EPS Growth (%) Chg in Financial Assets Accounts Receivable Turnover (x) Others -2 Inventory Turnover (x) Cash Flows from Fin Activities Accounts Payable Turnover (x) Chg in Financial Liabilities ROA (%) Chg in Equity 71 ROE (%) Dividends Paid ROIC (%) Others Liability to Equity Ratio (%) Increase (Decrease) in Cash Current Ratio (%) Beginning Balance Net Debt to Equity Ratio (%) Ending Balance Interest Coverage Ratio (x) Source: Company data, estimates 84

85 March 7, 217 ICD (491 KQ) Riding the OLED wave An OLED dry etcher and evaporator (Initiate) Buy Target Price (12M, W) 21, Share Price (3/6/17, W) 14,45 Expected Return 45% OP (17F, Wbn) 42 Consensus OP (17F, Wbn) EPS Growth (17F, %) 92.6 Market EPS Growth (17F, %) 16.9 P/E (17F, x) 7.6 Market P/E (17F, x) 9.6 KOSDAQ 64.5 Market Cap (Wbn) 238 Shares Outstanding (mn) 16 Free Float (%) 7.5 Foreign Ownership (%) 3.2 Beta (12M) Week Low 1,25 52-Week High 17,95 (%) 1M 6M 12M Absolute Relative ICD KOSDAQ Established in 2, ICD produces equipment for OLED manufacturing. Revenue expansion began in 25, when the company started supplying HDP etchers for SDC s 4.5G (A1) fab during the panel maker s first OLED capex cycle. The company s core products include HDP etchers (used in OLED production), evaporators, and electrostatic checks (ESC). Investment point 1: Riding the OLED wave ICD supplies evaporators, core equipment used in the production of flexible OLED displays, to Japan s Canon Tokki, which has a near monopoly in deposition equipment for small/mid-sized OLED. ICD s evaporators are used in assembling Canon Tokki s deposition equipment, which is then supplied to panel makers. We expect Canon s deposition equipment capacity to expand from four units (6, sheets/month) in 216 to eight units (12, sheets/month) in 217. We see ICD s evaporator revenue growing in proportion to Canon Tokki s capacity and revenue. We estimate revenue from Canon Tokki to climb from W58bn in 216 to W14bn in 217. Investment point 2: China s OLED capex in 2H17 We believe ICD s experience supplying for 6G flexible OLED lines gives it an advantage in the Chinese market, where its performance history should be viewed favorably. In particular, top Chinese panel suppliers like BOE and Tianma are likely to prefer ICD s equipment, given its proven track record with Samsung. We estimate the company s HDP etchers account for 9% of the etching equipment in Samsung s OLED lines. Initiate coverage with Buy and target price of W21, We initiate our coverage on ICD with a Buy rating and target price of W21,. We applied a 3% discount to the average P/E of global OLED equipment makers to account for the risk of new entrants in the dry etcher market. However, we note that ICD is one of the few equipment suppliers that count major global panel makers as customers. Even based on conservative assumptions of China s OLED investments and ICD s market share, we still expect to see meaningful earnings growth this year. Moreover, if talks of foldable display-related investments take place later this year, the company could see additional new orders. FY (Dec.) 9/13 9/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) OP (Wbn) OP margin (%) NP (Wbn) EPS (W) ,96 2,64 ROE (%) P/E (x) P/B (x) Dividend yield (%) Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, estimates 85

86 March 7, 217 Investment point 1: Riding the OLED wave ICD supplies evaporators, core equipment used in the production of flexible OLED displays, to Japan s Canon Tokki, which has a near monopoly in deposition equipment for small/mid-sized OLED. ICD s evaporators are used in assembling Canon Tokki s deposition equipment, which is then supplied to panel makers. OLED evaporation equipment evaporates red, green, and blue (R/G/B) organic materials on substrates. The equipment consists of: 1) a depositor; 2) a return logistics system; and 3) a light source. Potential competitors to Canon Tokki are Sunic System, SFA, and Japan-based Ulvac; however, we note that Canon Tokki is the only vendor that has a track record of supplying for 6G flexible OLED lines. We expect Canon s deposition equipment capacity to expand from four units (6, sheets/month) in 216 to eight units (12, sheets/month) in 217. Given the planned global additions of small/mid-sized OLED capacity through 22, we believe that the evaporation equipment market will remain in short supply, even after the vendor s capacity ramp-up. We see ICD s evaporator revenue growing in proportion to Canon Tokki s capacity and revenue. We estimate revenue from its Canon Tokki-bound supply to climb from W5.8bn in 216 to W14bn in 217. Figure 165. Structure of Canon Tokki s OLED evaporation equipment Table 33. OLED evaporation equipment suppliers Samsung LG Other overseas panel makers Deposition of R/G/B organic materials Canon Tokki Canon Tokki Sunic System Canon Tokki etc. (Sunic System, SFA, Ulvac etc.) Evaporator logistics ICD ICD Avaco, Invenia ICD Light source Samsung Yas (non-listed) - 86

87 March 7, 217 Investment point 2: China s OLED capex in 2H17 Figure 166. Planned OLED capacity additions by overseas panel makers Regarding the OLED-manufacturing process, HDP etchers, a flagship product of ICD, are used for etching of thin films (e.g., TI/Al/TI). We estimate that ICD s etchers account for a hefty 9% of all etching equipment in Samsung s flexible OLED lines. Samsung, ICD s key customer in the etching system segment, expanded its OLED panel production capacity by 15, sheets/month in 216, fueled by OLED panel adoption by Apple. However, Samsung is expected to add only 45, sheets/month to its OLED panel capacity in 217, which should lead to a decline in new OLED equipment orders for ICD. From 2H onwards, however, we think a pickup in OLED equipment orders from Chinese panel makers should help offset declining orders from key customer Samsung. We expect overseas panel makers in China, Japan, and Taiwan to collectively expand their small/mid-sized OLED capacity by at least 13, sheets/month in 217. ICD s potential competitors in this segment include Japan-based Tel and Koreabased Wonik IPS. Indeed, some of the aforementioned overseas OLED panel makers may adopt etchers produced by vendors other than ICD. However, we believe ICD s experience supplying for 6G flexible OLED lines gives it an advantage in the Chinese market, where its performance history should be viewed favorably. In particular, top Chinese panel suppliers like BOE and Tianma are likely to prefer ICD s equipment, given its proven track record with Samsung. We think the company s earnings could rise further, as it wins orders from Chinese and Japanese panel makers. ( : Order Equipment, : Install, : Production) 87

88 March 7, 217 Earnings outlook & valuation For the full year of 217, we forecast ICD s revenue at W32.6bn (+38.9% YoY), and operating profit at W42.3bn (+158.% YoY). Evaporator revenue, in particular, should nearly double YoY, aided by capacity ramp-up by Canon Tokki. For HDP etchers, fresh revenue from its anticipated supply to Chinese panel makers in 2H should help offset a likely dip in Samsung-bound revenue. We initiate our coverage on ICD with a Buy rating and target price of W21,. We applied a 3% discount to the average P/E of global OLED equipment makers to reflect the risk of new entrants in the dry etcher market. However, we note that ICD is one of the few equipment vendors that count major global panel makers as customers. Moreover, additional capex by Canon Tokki would provide an additional boost to its earnings. Even based on conservative assumptions of China s OLED investments and ICD s market share, we still expect to see meaningful earnings growth this year. Table 34. Valuation 12M forward EPS (W) 2,116 Current P/E (x) 7.2 Target P/E (x) 1. TP (W) 21, Current price (W) 14,45 Upside (%) 45. Remarks 3% discount to global peers average P/E, risk of new market entrants Table 35. ICD s earnings trends & outlook (Wbn, %) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F 16 17F Revenue OLED equipment HDP etcher Evaporator & asher Parts & other (%) OLED equipment HDP etcher Evaporator & asher Parts & other OP Pre-tax profit NP OP margin Pre-tax margin Net margin Growth (QoQ/YoY, %) Revenue OLED equipment HDP etcher Evaporator & asher Parts & other OP Pre-tax profit NP

89 March 7, 217 [Appendix] Company overview Established in 2, ICD produces equipment for OLED manufacturing. Revenue expansion began in 25, when the company started supplying HDP etchers for SDC s 4.5G (A1) fab during the panel maker s first OLED capex cycle. The company s core products include HDP etchers (used in OLED production), evaporators, and electrostatic chucks (ESC). HDP etchers, which are used for etching of thin film as part of the TPS array process, can be applied to the etching processes for gate, source/drain, contact hole, Octa, PR ashing, and active. ICD s etchers currently represent a hefty 9% of all etching equipment installed in Samsung s flexible OLED lines. ICD s evaporators are used in assembling Canon Tokki s deposition equipment, which is then supplied to panel makers. We thus see ICD s evaporator revenue growing in proportion to Canon Tokki s capacity and revenue. Electrostatic chucks (ESC) are consumable parts for use in etchers, keeping the temperature of glass substrates at steady levels. As such, the company sees ESC revenue increasing in tandem with its etching equipment revenue. Figure 167. ICD s shareholding structure (as of 3Q16) Figure 168. Revenue breakdown by business (216) Affiliates 27% Parts & other 15% Other 73% Evaporator & asher 32% HDP etcher 53% Figure 169. HDP etcher Figure 17. Required equipment in OLED-manufacturing process 89