Dufu

Dufu posts strong 2Q09 recoveryfrom Insider Asia


HARD-DISK drive component manufacturer Dufu Technology Corp's (44 sen) results for the second quarter (2Q) and first half (1H) of FY December 2009 were within our expectations. More importantly, they showed a very strong recovery in earnings in 2Q.

The company's net profit of RM3.3 million for 1H09 accounted for just over half of our full-year forecast of RM6 million. With the second half expected to be much stronger, particularly in 4Q09, our full-year forecast will likely be exceeded, but we are keeping it unchanged for now.

As we had noted earlier, the worst of the global economy and the hard-disk drive (HDD) sector was over in 1Q09. The worst period was in January-February 2009, when there was a dearth of orders due to destocking activities at the height of the global crisis.

Since then, sales have rebounded strongly, especially in 2Q09, as the economy started to bottom out and orders picked up. This was reflected in Dufu's latest 2Q09 results, which saw a strong quarter-on-quarter (q-o-q) growth in revenue and earnings — although they were still lower year-on-year (y-o-y) due to the high base last year.

For 2Q09, Dufu's revenue rose 23.2% q-o-q to RM28.4 million. Pre-tax profit increased by a wider margin of 41.6% q-o-q to RM2.4 million while net profit rose 59.4% q-o-q to RM2 million.

The disproportionately larger growth in profits was due to economies of scale and some cost-cutting measures. Capacity utilisation improved from 50%-60% in 1Q09 to 70%-75% in 2Q09, and has increased further to 80% at present. As a result, pre-tax margins improved from 7.3% in 1Q09 to 8.4% in 2Q09.

On a y-o-y basis, 2Q09 was still weaker than a year earlier, due to last year's higher base before the global financial crisis accelerated. Compared with 2Q08, the quarter's revenue slipped 4%, pre-tax profit was down 19.5% while net profit was 26.3% lower.

For 1H09, the company's revenue fell 10.9% y-o-y to RM51.5 million. Pre-tax profit declined 32.7% y-o-y to RM4.1 million while net profit fell 42.1% y-o-y to RM3.3 million.

Despite having paid RM15 million so far for Futron, Dufu's balance sheet remains in good shape. As at June 2009, net debt stood at RM18 million, with gearing at a modest 22.5%.

HDD demand to be resilient
The HDD industry was relatively resilient until the global crisis became more pronounced in late 2008 and early 2009. 1Q09 marked the low for the industry. In normal times, the first quarter is already a seasonally slow one — coming after the pre-Christmas production period. This time, the industry had to contend with the global recession that crimped consumer spending.

Since then, sales have rebounded strongly, especially in 2Q09, as the economy started to recover and orders picked up. Recent export data for Asian economies have also started to show improvement from earlier lows.

The recovery in HDD sales — as experienced by Dufu and main competitor Notion VTec — has been strong on a month-on-month (m-o-m) basis, attesting to the demand for HDD products, as compared to other electronics products.

While the outlook for export-oriented companies remains tied to that of the US economy, there are encouraging signs that the world's largest economy has bottomed and is starting to recover. However, the road to recovery will take some time, and future growth is likely to be slow.

The biggest risk for exporters is the strength of the US recovery, which depends on consumer spending. With consumers still trying to de-gear and a poor labour market, consumer spending will likely look weak for a while.

However, we expect the HDD industry to be resilient and recover quickly, although there are marked differences in performance between the major players, depending on their product, pricing and inventory strategies.

Demand for HDD is being increasingly driven by the need for storage for applications for Internet-based applications, as well as technological advances and innovation for consumer electronics products.

Global Internet penetration is rising and web-based applications such as blogs, social networking and emails are gaining popularity in usage, irrespective of economic conditions.

Futron to anchor expansion plans
Dufu saw the worst in terms of sales in 1Q09 — notably in January-February 2009. From 2Q09 onwards, sales have rebounded strongly. The company's capacity utilisation dropped to just 50%-60% in the first quarter, but rebounded to 70%-75% in 2Q09 and have now stabilised at around 80%.

Over the longer term, the acquisition of Futron Technology Ltd, completed in January 2009, provides a platform for future expansion, at a very reasonable price. Futron, a Hong Kong-based HDD manufacturer with operations in China, was acquired for about RM20 million.

The purchase priced Futron at around book value with a profit guarantee of RM5 million, which can be offset against the purchase price in the event of a shortfall. Of the purchase consideration, RM15 million has been paid and the balance of RM5 million is due next year, subject to the profit guarantee.

Futron produces HDD components, compressor and sensor components and was a subcontract producer for Dufu. We understand some orders have been shifted to Futron to take advantage of the lower operating cost structure there, and this should boost margins over time. Until the recent crisis, Dufu's 120,000-sq ft factory in Penang was already fully utilised. Futron's factory, near Guangzhou, China, has 90,000 sq ft of usable space and a much lower operating cost structure.

We are maintaining our forecasts for now, although they are likely to be exceeded. We expect Dufu's sales to fall 18% in 2009 before recovering by 10% in 2010. As a result, we expect a 37% fall in pre-tax profit to RM6.6 million and a 41% decline in net profit to RM6 million for 2009.

Just as profits fall disproportionately more than revenue in 2009, the same applies when revenues recover in 2010. We expect both pre-tax and net profit to rise 47% to RM9.7 million and RM8.8 million, respectively in 2010.

At 45 sen, Dufu's shares are trading at a significant 30% below its book value of 65 sen, with low single-digit price-to-earnings (P/E) multiples of just nine and 6.1 times 2009-10 earnings, respectively.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.