Tuesday, 08 December 2009 17:23
NOTION VTec's recent strong results and increase in investor interest is a testament in part to the resilience of the hard disk drive (HDD) industry, as well as the strengths of the local precision component players in finding market niches.
Notion's main listed rival, Dufu Technology Corp (44 sen) has also seen its earnings recover strongly, especially in the third quarter of 2009 (3Q09), although its scale of operations and levels of profitability are much smaller than Notion's.
The Penang-based company has withstood many cycles profitably in its 22-year history, a testament to its resilience and cost control efforts. Its future growth will centre on newly acquired Futron Technology, whose plant in China will be able to cater for larger orders and at lower costs.
At 44 sen, Dufu's shares are trading at a significant 35% discount to their latest book value of 68 sen per share. Price-to-earnings (P/E) valuations are in the low single digits, at just 6.2 and 5.6 times 2009-10 earnings
Strong 3Q09 results
Dufu's recently released 3Q FY Dec 2009 results were well above expectations, with net profit of RM3.2 million, up 54% year-on-year (y-o-y) and almost equivalent to the RM3.3 million achieved for the first half of 2009 (1H09). Indeed, its net profit of RM6.5 million for the nine months to September 2009 has exceeded our earlier full-year forecast of RM6 million, which we are revising upwards by 42% to RM8.5 million.
The strong earnings in 3Q09 were largely due to sharply higher margins, which was the result of better product mix within the HDD segment (especially for spacers versus pins) and various cost-cutting efforts in 1Q-2Q09 which paid off in 3Q09 as volume and economies of scale kicked in.
This resulted in 3Q09 gross profit margins expanding from 15.4% to 27.2% y-o-y. Pre-tax profit margins for the quarter rose from 6% to 12.7%
y-o-y.
As a result, pre-tax profit for the quarter increased by a significant 67.9% y-o-y to RM3.7 million, and up from RM2.4 million in 2Q09. Revenue, however, declined 20.6% y-o-y to RM28.8 million, due to the high base last year, before the financial turmoil.
For the first nine months of 2009, Dufu's revenue fell 14.6% y-o-y to RM80.3 million, pre-tax profit fell 6% y-o-y to RM7.7 million while net profit fell by 16.7% y-o-y to RM6.5 million. Gross margins for the nine-month period rose from 18.6% to 21.5%.
The worst for the global economy and HDD sector was in 1Q09, especially January-February 2009. Since then, sales have rebounded strongly, especially in 2Q09. This was sustained into 3Q09 — although there was not much further quarter-on-quarter (q-o-q) growth. Quarterly revenue was sustained at just over RM28 million in 2Q09 and 3Q09.
Despite having paid RM16 million so far for the earlier acquisition of Futron Technology, Dufu's balance sheet remains in good shape. As at Septemebr 2009, net debt stood at RM19.2 million, with modest gearing of 23.5%. This was slightly higher than June 2009's net debt of RM18 million.
Earnings outlook
With our earlier full-year net profit forecast of RM6 million already exceeded in the first nine months, we are revising upwards our forecast by 42% to RM8.5 million for 2009 and by 8% to RM9.5 million for 2010.
This will close 2009 with just a small annual net profit decline of 16%, from RM10.2 million to RM8.5 million, despite the severity of the recession earlier, especially in 1Q09. We expect net profit to rise 12.2% to RM9.5 million in 2010.
The fourth quarter of the year is traditionally the strongest for HDD component players (except last year), due to the pre-Christmas orders. While Dufu's revenue for 4Q09 will likely to be higher than in 3Q09, we understand margins will be lower. The strong improvement in margins for 3Q09 was due to better product mix and various earlier cost-cutting efforts. But as the overall scale of business increases again, its cost structure will also increase.
Futron to spearhead future growth
Over time, Dufu's overall margins will improve due to the shift towards China, where its newly acquired subsidiary Futron Technology is producing a larger proportion of its HDD components at much lower costs.
Futron provides a platform for future expansion for Dufu at a very reasonable price. Recall that Futron was acquired for about RM20 million, or around book value with a profit guarantee of RM5 million. Of the purchase consideration, RM16 million has been paid and the balance of RM4 million is due next year, subject to the profit guarantee.
Futron's factory, near Guangzhou, China, presently has 90,000 sq ft of usable space, while Dufu's original plant in Penang has 120,000 sq ft.
We understand Futron's factory is now operating at almost full capacity, but can be easily expanded. The Penang plant operates at about 80%-90% capacity for spacers, and 50%-60% for pins and stamping. This still allows some room for new businesses and revenue growth there without heavy capex needs.
Positive outlook for HDD demand
The outlook for the HDD industry remains favourable. In fact, the industry was relatively resilient until the global crisis became more pronounced in late 2008 and early 2009, and the recovery has also been very swift.
The outlook for export-oriented companies remains tied to that of the US economy, and will also be affected by USD-RM exchange rate movements.
The world's largest economy is starting to recover from its worst recession in decades, but the road to recovery will not be smooth and future growth is likely to be slow. With US consumers still trying to de-gear amid high unemployment, consumer spending will likely look weak.
Nonetheless, we expect the HDD industry to be resilient. As the global recovery gathers steam, HDD demand has improved further with world HDD shipment in the September quarter rising 15% q-o-q to 152 million units compared to 132 million units shipped for the June quarter.
Demand for HDD is being increasingly driven by the need for storage, 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.
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.