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PP 7767/09/2010(025354)

Malaysia

MARKET DATELINE

Corporate Highlights

Briefing Update

Notion Vtec

Limited Visibility

9 August 2010
9 August 2010

RHB Research Institute Sdn Bhd A member of the RHB Banking Group

Company No: 233327 -M

 

9 August 2010

Share Price

:

RM2.04

Fair Value

:

RM1.54

Recom

:

Underperform

 

(Maintained)

Table 1 : Investment Statistics (NOTION; Code: 0083)

Bloomberg: NVB MK

 

Net

Basic

FD EPS

Net

FYE

Revenue

Profit

EPS

FD EPS

Growth

PER

C.EPS*

P/CF

ROE

Gearing

GDY

Sep

(RMm)

(RMm)

(sen)

(sen)

(%)

(x)

(sen)

(x)

(%)

(x)

(%)

2009

172.7

36.0

25.6

25.6

6.6

8.6

-

2.6

24.0

0.2

1.7

2010f

205.8

31.4

20.3

18.7

(20.6)

10.8

30.0

2.5

18.0

0.1

2.2

2011f

250.6

32.4

21.0

19.3

3.1

10.5

37.0

2.2

16.5

0.1

2.2

2012f

311.5

34.8

22.5

20.5

7.4

9.8

42.0

2.0

15.8

0.1

2.2

Main Market Listing / Non-Trustee Stock / Syariah-Approved Stock By The SC

* Consensus Based On IBES Estimates

Higher costs. The company’s initial capex of RM80m was to expand capacity for the 2.5’’ baseplate capacity to 5m/month in FY9/11 and 7m/month in FY9/12. However, due to higher-than-expected rejected rates, management now expects to hold production capacity at 2m/month in FY9/11. We believe the excess capacity and operational issues will dampen the earnings outlook in the medium term. Management stated that it will review plans for the 2.5” baseplate, and potentially “cut loss” on the project within the next nine months.

Lost sales due to contamination. Going forward, the company expects lower sales volume from the HDD segment due to loss of one of the anti- disk supply contracts (ultimately for Western Digital) due to quality issues, which has affected the company since the 2QFY9/10. However, we note that the company will still be supplying for the remaining three anti-disk programmes.

2.5” baseplate capacity can be used for camera segment

While

management is committed to making the 2.5” baseplate project work, and to rectify all quality issues, the company also needs to produce more than 1m/month to break even. Currently Notion is only producing around 400k/month, notwithstanding the high reject rate. Assuming management is unable to turn the project around within three quarters, management will scrap the project and redeploy the spare capacity from the CNC and die casting machines to the camera business.

… but camera segment margins would then be affected. However, we note that the camera business is a relatively low volume business, and therefore Notion would have too much machining and die-casting capacity, which would then eat into the camera segment’s margins. This implies that the negative impact to earnings could persist beyond three quarters.

Issued Capital (m shares) Market Cap (RMm)

 

154.6

315.3

Daily Trading Vol (m shs)

5.2

52wk Price Range (RM)

3.521.48

Major Shareholders:

 

(%)

Choo Wing Hong

14.2

Choo Wing Onn

9.5

Nikon

9.0

FYE Sep EPS chg (%)

FY10

FY11

FY12

-

-

-

Var to Cons (%)

-37.5

-48.0

-51.1

PE Band Chart

PER = 11x PER = 8x PER = 5x
PER = 11x
PER = 8x
PER = 5x

Relative Performance To FBM KLCI

Notion Vtec FBM KLCI
Notion Vtec
FBM KLCI

Risks to our view. 1) Rise in prices of raw materials; and 2) Fluctuations in the exchange rate.

Forecasts and recommendation. Management guided for a slower 4QFY9/10 but as we highlighted above, there is still poor visibility on longer-term earnings. Our forecasts are unchanged and show flattish growth for FY11-12 but we could still be over-optimistic. Likewise, we warn that there could still be downside risk to our fair value of RM1.54 based FY9/11 8x FD EPS. We thus reiterate our Underperform call on the stock.

Please read important disclosures at the end of this report.

Yap Huey Chiang (603) 92802166 yap.huey.chiang@rhb.com.my

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Salient Points From Analysts’ Briefing

9 August 2010

Disappointing results explained. Management highlighted key issues in relation to the sharp decline in its 3QFY9/11 earnings. To recap, 9MFY9/10 net profit was below our and consensus expectations, accounting for 71.1% and 55.8% of our full-year and consensus forecast respectively. 3QFY09/10 revenue grew 7.2% qoq and 36.0% yoy but earnings dropped 74.9% qoq and 72.2% yoy.

High reject rates for 2.5” baseplates to blame. The 2.5” HDD baseplate project is the main reason for the poor results. Together with the company’s ongoing capex of RM80m (of which 80% has been spent) to expand the 2.5’’ baseplate capacity to 2m/month by end-FY10, the high reject rate of 20-25% has resulted in zero revenue from the project but significant costs (see Table 2). We understand that the high reject rate was due to problems during the casting and moulding process. Management now expects the budgeted capex to raise the production capacity to a maximum of 2m/month in FY11. Note that current capacity for the baseplates stands at

400k/month.

Table 2: Higher Costs in 3QFY09/10

 

(RMm)

1 Loss from anti-disk

0.45

2 Anti-disk compensation

0.54

3 Additional labour

1.20

4 Levy on foreign labour

0.53

5 R&D

1.30

6 Lubricant change

0.25

7 Maintenance

0.98

8 Depreciation

1.00

9 Effect of foreign exchange

1.95

10 Rental of Plant 3

0.21

11 Finance costs

0.42

Total

8.83

Source: Company

Lost sales due to contamination. Going forward, the company expects lower sales volume from the HDD segment due to losing one of the anti-disk programmes for contamination. This prompted Notion to outsource the washing and e-coating process which resulted in additional costs. As highlighted in Table 2, the loss also resulted in compensation (i.e. to replace the rejects). However, we note that the company will still be running the remaining three anti-disk programmes.

Limited visibility for HDD. While management now expects lower overall contribution for its HDD segment, we highlight potentially weaker-than-expected sales volume as we note the less optimistic guidance from major HDD vendors i.e. Western Digital (WD) and Seagate. In addition, we note that WD reported a US$4 drop in its ASP in its 2QCY10 results due to more intense competition amongst HDD players. The price competition may persist and therefore continue to affect Notion’s selling prices.

Final decision on the 2.5” baseplate project by Mar. While management is committed to making the 2.5” baseplate project work, and to rectify all quality issues, the company also needs to produce more than 1m/month to break even. Currently Notion is only producing around 400k/month, notwithstanding the high reject rate. Assuming management is unable to turn the project around within three quarters, management will scrap the project and redeploy the spare capacity from the CNC and die casting machines to the camera business.

Camera segment margins could be affected. However, we note that the camera business is a relatively low volume business, and therefore Notion would then have too much machining and die-casting capacity, which would eat into the camera segment’s margins. This implies that the negative impact to earnings could persist beyond three quarters.

New orders for the camera segment. Nevertheless, management highlighted it will receive new orders for the camera segment for its new lens mounting components. We understand the lens mounting would require 12 separate components. Margins are typically higher than for the HDD segment, and hence should contribute positively to Notion’s earnings. However, volume loading for the component would only commence in FY11.

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9 August 2010

Capex. Given the negative outlook for the HDD segment, management plans to focus on the camera segment going forward. The company plans to spend RM30m in FY11 on the business, of which RM20m will be for capacity expansion for the lens mounting project and RM10m to expand its Thailand plant.

Maintain dividend payout. Despite lower earnings, management plans to maintain its 20% dividend payout for FY10-12. Based on our forecasts, we estimate operating cashflow of RM55.8-77.9m p.a., which will be able to cover the payout.

Risks and mitigating factors. We believe Notion’s risks include: 1) Rise in prices of raw materials i.e. aluminium alloys account for 27% of total costs); and 2) Fluctuations in the exchange rate (90% of revenue is in USD). In mitigation, we note that the company is focused on: 1) cost-cutting initiatives including in-house tooling capabilities; and 2) putting into place hedging policies to alleviate the exchange rate volatility.

Forecasts and Recommendation

Forecasts and recommendation maintained. Management guided for a slower 4QFY9/10 but as we highlighted above, there is still poor visibility on longer-term earnings. Our forecasts are unchanged and show flattish growth for FY11-12 but we could still be over-optimistic. Likewise, we warn that there could still be downside risk to our fair value of RM1.54 based FY9/11 8x FD EPS. We thus reiterate our Underperform call on the stock.

Table 3. Earnings Forecasts

Table 4. Forecast Assumptions

FYE Sep (RMm)

FY09

FY10F

FY11F

FY12F

FYE Sep

FY10F

FY11F

FY12F

HDD

69.1

82.9

103.6

129.5

Revenue growth (%)

19.2

21.8

24.3

Camera

74.3

90.6

111.4

139.3

HDD

20.0

25.0

25.0

Auto/industrial

29.4

32.3

35.5

42.6

Camera

22.0

23.0

25.0

Turnover

172.7

205.8

250.6

311.5

Auto

10.0

10.0

20.0

EBITDA

63.9

58.6

72.7

84.6

Total Shipments units (m)

FY10

FY11

FY12

EBITDA margin (%)

37.0

28.5

29.0

27.2

HDD

36.7

40.9

40.3

 

Camera

8.8

10.6

12.9

Depreciation

(18.2)

(19.6)

(29.2)

(37.7)

Auto/others

2.1

2.3

2.9

EBIT

45.7

39.0

43.5

46.9

RM:US$ exchange rate

3.30

3.25

3.20

EBIT margin (%)

26.5

19.0

17.4

15.0

 

Source: RHBRI estimates

Interest expense

(3.7)

(4.1)

(4.9)

(5.4)

Associates

1.0

1.0

0.0

0.0

Pretax profit

43.0

36.0

38.6

41.4

Taxation

(7.0)

(5.8)

(6.2)

(6.6)

Minority interest

0.1

0.2

0.0

0.0

Net profit

36.0

31.4

32.4

34.8

Source: Company data, RHBRI estimates

IMPORTANT DISCLOSURES

This report has been prepared by RHB Research Institute Sdn Bhd (RHBRI) and is for private circulation only to clients of RHBRI and RHB Investment Bank Berhad (previously known as RHB Sakura Merchant Bankers Berhad). It is for distribution only under such circumstances as may be permitted by applicable law. The opinions and information contained herein are based on generally available data believed to be reliable and are subject to change without notice, and may differ or be contrary to opinions expressed by other business units within the RHB Group as a result of using different assumptions and criteria. This report is not to be construed as an offer, invitation or solicitation to buy or sell the securities covered herein. RHBRI does not warrant the accuracy of anything stated herein in any manner whatsoever and no reliance upon such statement by anyone shall give rise to any claim whatsoever against RHBRI. RHBRI and/or its associated persons may from time to time have an interest in the securities mentioned by this report.

This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this report may not be suitable for all investors. RHBRI recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Neither RHBRI, RHB Group nor any of its affiliates, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this report.

RHBRI and the Connected Persons (the “RHB Group”) are engaged in securities trading, securities brokerage, banking and financing activities as well as providing investment banking and financial advisory services. In the ordinary course of its trading, brokerage, banking and financing activities, any member of the RHB Group may at any time hold positions, and may trade or otherwise effect transactions, for its own account or the accounts of customers, in debt or equity securities or loans of any company that may be involved in this transaction.

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9 August 2010

“Connected Persons” means any holding company of RHBRI, the subsidiaries and subsidiary undertaking of such a holding company and the respective directors, officers, employees and agents of each of them. Investors should assume that the “Connected Persons” are seeking or will seek investment banking or other services from the companies in which the securities have been discussed/covered by RHBRI in this report or in RHBRI’s previous reports.

This report has been prepared by the research personnel of RHBRI. Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of the “Connected Persons,” including investment banking personnel.

The research analysts, economists or research associates principally responsible for the preparation of this research report have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors and firm revenues.

The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or more over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take on higher risks.

Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.

Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.

Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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This report may not be reproduced or redistributed, in whole or in part, without the written permission of RHBRI and RHBRI accepts no liability whatsoever for the actions of third parties in this respect.

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