An unexpected combination of consumer behaviour and government regulation has caused a surge in demand for high-definition flat-screen televisions. And if investors want to benefit from this subsector’s growth, analysts say, they should consider investing in flat-panel manufacturers ahead of an even bigger boom that awaits when the economy recovers.

Shipments of flat-screen TVs — including plasma and liquid crystal display panels — to North American retailers rose to eight million units in the quarter ended March 31, up from the 6.2 million units shipped during the same period in 2008, according to Austin, Tex.-based DisplaySearch.

The soaring sales of these TVs in the first quarter of 2009 have been an anomaly, considering economic conditions and that people usually buy a new TV when they buy a new house, says Shawn DuBravac, chief economist for the Arlington, Va.-based Consumer Electronics Association: “You typically don’t buy a TV in a recession — especially when you’re watching your budget and you already own three of them.”

“Cocooning consumers” are the main force driving sales, says Riddi Patel, principal analyst of TV systems for El Segundo, Calif.-based digital market research firm iSuppli Corp.: “In the current financial situation, we find consumers are cutting back on luxury expenses, such as big travel plans, and they are spending more time at home.”

Nicholas Teo, an analyst in Tai-wan with Sydney, Australia-based Macquarie Securities Ltd., agrees: “During an economic downturn, people tend to seek cheaper forms of entertainment, so buying a TV to play video games or watch movies is a more affordable way to spend time than going out.”

Furthermore, the counter-cycli-cal boom is being driven by the low price of flat-screen TVs, Patel says, pointing out that “TV prices are declining very rapidly.”

She notes that 10 years ago, a 29-inch cathode-ray tube TV set sold for $1,000. “Today, for the same $1,000, I can buy a 50-inch plasma or a 40-inch LCD TV. You can now get a larger TV with better technology that looks more attractive,” she adds, noting that flat-screen TVs are thinner and take up much less room than the old-school CRT TVs.

Another factor that will push CRT TVs further down the road toward obsolescence is the new rules in the U.S. and Canada mandating TV stations to pull the plug on analog broadcasts and begin transmitting content digitally. This will ensure that sales of flat-screen TVs will continue to rise beyond the downturn, as CRT TVs can read only analog broadcast signals.

All U.S. broadcasters made the transition on June 12, while Canadian broadcasters will have to follow suit by Aug. 31, 2011. As a result of these regulations, consumers are left with two options, says Teo: “They can either get a digital-to-analog converter box for their CRT TV … or they can just buy a flat-screen.”

Although buying a converter box is cheaper — one costs between US$20 and US$60 — consumers are most likely to upgrade to a flat-screen TV. “Choosing to set up the digital-to-analog converter box is like buying a great stereo and pairing it with bad speakers,” Teo says, noting that, even with a converter box, CRT TVs don’t have the capacity to receive and interpret all of the high-def signals. Thus, he adds, “The picture will look kind of fuzzy.”

For investors looking to benefit from this trend of increased flat-screen TV sales, Teo suggests looking beyond the brand-name companies on the shelves of your local electronics retailer and focus on the companies that manufacture the plasma or LCD panels instead. “The brands themselves aren’t directly benefiting, he says, “because [retail] prices are so low and there’s a lot of price competition between [them]” — which has led to lower profitability on TVs.

However, the story is much different for the panel makers, as global demand for panels is exceeding supply at a rapid pace.

“The panel makers are benefiting because they have really reduced their [manufacturing capacity] when we were in the thick of the financial crisis, thinking TVs weren’t going to sell at all,” says Teo. “But there was a sudden, stronger than expected pickup in demand. Now the factories building these panels are at capacity. [And with] demand still exceeding supply, they’re continuing to raise their prices.”

@page_break@Taiwan-based AU Optronics Corp. , one of the largest panel manufacturers in Asia, is worth keeping an eye on, Teo says. For the quarter ended March 31, AUO pulled in revenue of US$1.5 billion (converted from 50.7 billion new Taiwan dollars), a drop from US$4.3 billion for the same period in 2008. This resulted in a loss of US$594.8 million in the recent quarter, vs net income of US$855.4 million for the same period a year prior.

AUO’s American depository receipts, which trade on the New York Stock Exchange, closed at US$9.62 on June 16. “The shares have more upside,” Teo says, “because demand will be fairly solid into the second half of the year and supply will continue to be limited.”

South Korea-based Samsung Electronics Co. Ltd. will also share in the benefits as a panel maker, as it opened its own internal panel-making factory in partnership with Japan-based Sony Corp. in 2004, known as S-LCD Corp.

“However, even though Samsung has its own internal panel supply, it isn’t immune to a shortage,” Teo says, “That’s why Samsung remains AUO’s largest customer.”

Samsung pulled in revenue of US$13.1 billion (converted from 18.6 trillion won) for the quarter ended March 31, a decrease from the US$17.9 billion it earned in the same quarter in 2008. Its net income fell to US$437.6 million from US$2.3 billion a year earlier due to losses in its semiconductor business. That said, Samsung’s premium product line of light-emitting diode TVs turned a profit of US$268.2 million, compensating for the loss.

Samsung’s shares currently trade on the Seoul Stock Exchange and on the London Stock Exchange in the form of global depository receipts.

The last player worth looking at is Taiwan-based InnoLux Display Corp., a panel supplier renowned for keeping its manufacturing costs lean, Teo says.

InnoLux brought in revenue of US$5.2 billion (NT$163.9 billion) for the year ended Dec. 31, 2008, an increase from US$4.8 billion in 2007. Its net income dropped to US$153.9 million from US$491.6 million, says Teo, due to an oversupply of panels in its inventory.

InnoLux, which now has a supply shortage, Teo says, will most likely see profits resulting from the increased demand for flat panels in its next quarterly statement. InnoLux’s shares trade on the Taiwan Stock Exchange.

“Sometimes these panel makers go through periods of oversupply, in which they see prices fall and they all get into trouble and lose money,” Teo says. “Then, there are periods in which they cut back on expansion and there’s a shortage [so] they enjoy the profits. The challenge for them is to minimize the cycle and make as much profit as possible on a consistent basis.” IE