LG Innotek has become increasingly vulnerable to the so-called Apple risk, as the U.S. technology giant is cutting reliance on parts manufactured by the component-making affiliate of LG Group.
The company showed robust performance in the first half but it will most likely see a profit squeeze due to falling profit margins caused by Apple's reduction of purchases of Innotek's products.
Given its heavy dependence on Apple, the firm is highly likely to experience a downturn again unless it finds new customers to replace the U.S. firm. Apple is one of its biggest clients along with LG Electronics.
"Innotek has ‘client' problems. It's been generating revenue by selling its components to LG Electronics and Apple. But the margin is very thin. If Innotek fails to add new customers, then its position will fall to a ‘second-tier' parts supplier," said a senior fund manager at a Europe-based investment bank, adding the bank isn't considering buying more Innotek shares.
Innotek offers liquid crystal display (LCD) modules, digital tuners, motors, protection circuit modules, power and wireless modules and radio frequency (RF) components for companies operating in mobile, display, network and car electronics markets.
"There are multiple risks that can hurt Innotek's bottom line: slower-than-expected demand for light-emitting diode (LED) application, fiercer competition for camera modules, and sluggish demand for backlight units hit by faster migration toward organic LED or OLED devices," said an another fund manager at a U.S.-based investment bank in Seoul.
He stressed the bank advised its clients to sell Innotek shares, citing such business uncertainties.
"The problem is Apple is asking Innotek to supply camera modules with heavy discounts, which the firm can't refuse as they want to be recognized as one of Apple's trusted suppliers," said the manager at the European bank.
"Innotek knows its Apple business can't generate the profit that it wants. The irony is it can't depart from Apple," another analyst said.
Market participants' negative outlook may come as a surprise for the company as it posted sales and operating profit of 1.5 trillion won and 35.7 billion won, respectively, up 23 percent and 111 percent from a year ago.
The company admitted that it is concerned about the Apple risk.
"The iPhone maker is looking to source parts other than Innotek. The impact of the ‘Apple effect' will be short-lived but it is not good," said an unnamed Innotek official. In this regard, LG Electronics smartphone business is crucial for Innotek.
LG Electronics' smartphone sales momentum continued to be strong, and Bernstein Research said shipment growth will be sustainable in the medium-term.
But Bernstein, an independent research unit of AllianceBernstein, said the big question for LG Electronics is how successful LG can be in the elusive premium smartphone segment, another blow for Innotek in terms of magnitude in the improvement of their profits.
CEO Lee Woong-beom seems passive about transforming the firm into a rapid one that will enable it to effectively tide over the challenging market situation, as Innotek scrapped its plan to unload some of its money-losing divisions.
According to sources from local investment banks, Innotek has canceled its earlier plan to sell two unprofitable divisions.
"The reason was simple but looks silly. If Innotek pushes the restructuring plans as scheduled, then that's another sign that the company admits its business is struggling," said the manager.
"No imminent breakthroughs are in sight and the company's top management has no power to push restructuring plans. That's why questions still remain about the company's long-term corporate sustainability. This is an unresolved issue and will remain unresolved," said a source at LG.
Innotek said it is trying hard to improve its profitability and cut costs.