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Will Himax Technologies' Augmented-Reality Bet Pay Off?

2017 has turned out to be a great year for investors in Himax Technologies (NASDAQ: HIMX), with the stock is up more than 36% so far. The semiconductor and sensor specialist's terrific rally has been driven by rumors that it might become a supplier to Apple for the next iPhone, thanks to its growing bets on augmented-reality (AR) technology.

Himax expects big gains from AR technology. The company is adding more wafer-level optics (WLO) and liquid-crystals-on-silicon capacity (LCOS) capacity by ramping up its research and development expenditure in the hope of a jump in orders from customers looking to deploy AR technology.

But is the AR bet going to pay off? Or will Himax investors get a sense of deja vu just like the Google Glass days, when its last big project turned out to be a damp squib? Let's find out.

Image source: Getty Images.

A closer look at the AR opportunity

Zion Market Research forecasts that the global AR market will grow at an annual pace of 85% until 2021, hitting a size of $134 billion. With that growth will come demand for related hardware components such as head-mounted displays, camera processors, and sensors. IDC forecasts that shipments of AR hardware will jump from just 0.4 million units this year to 45.6 million in 2020.

Himax, therefore, is investing aggressively to ramp up the production of AR-related hardware, such as WLO and LCOS, which are used to manufacture head-mounted displays and enable 3D scanning. The chipmaker's research-and-development expenses are set to rise 28% year over year during the second quarter, with higher WLO capacity accounting for half of the increase.

More specifically, Himax is going to spend $60 million this year to ramp up its WLO capacity, as it anticipates a major bump in near-term demand from some of its AR customers. Furthermore, Himax believes that its WLO investments will bear fruit in the long run, as 3D more smartphone makers adopt scanning technology.

Grand View Research puts the size of the smartphone 3D scanning market at more than $2 billion in 2022. By comparison, Himax has generated $777 million in revenue over the past year, so it doesn't want to miss the 3D scanning gravy train, since it represents a huge market opportunity.

What's more, the company's 3D scanning dreams could receive a big shot in the arm if Apple decides to use Himax's 3D-sensing module in the next iPhone -- though investors should take this possibility with a pinch of salt. It's just speculation at this point, and the company has dropped hints that it won't start seeing AR-related gains anytime soon.

Himax investors shouldn't bet the house on AR

The future of AR could indeed unfold slowly for Himax. For example, a big AR customer decided to stop using Himax chips as it moves to a next-generation platform. We don't know whether this customer will come back to Himax for newer-generation chips, but the Himax's business is going to take a hit in the second quarter from lower WLO shipments.

Moreover, the company hasn't spoken about landing any firm orders, apart from one short-term commitment that has triggered the frenzied investment in WLO capacity. Himax management is optimistic that its WLO capacity investments will bring new agreements in the second half of the year, but a failure to bring in new deals will render the investments useless.

Himax management is talking about having a lot of smartphone customers coming in and requesting support for WLO, but the talk needs to translate into revenue growth later in the year. For now, the company's guidance doesn't match management's optimism: The midpoint of its second-quarter revenue guidance indicates that Himax's top line will drop almost 25% year over year.

Analysts aren't too optimistic about Himax's performance, either, as they project a 17% revenue decline for fiscal 2017, which will lead to a weak earnings performance. At the same time, Himax is quite expensive, at 36 times last year's earnings, way higher than its 13-year median price-to-earnings ratio of 17.

What's even more surprising is that Himax shares could become more expensive in the next year. Wall Street projects a forward P/E ratio of 48, thanks to a potential drop in earnings.

Investors, therefore, should adopt a wait-and-see approach despite the hoopla around AR technology. Himax shares seem to have run up too fast this year, driven by rumors and speculations, not by any concrete financial gains.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.