Sunday, August 15, 2010
Notion Vtec : Uncertainty is an opportunity?
Established in 1995, Notion VTec has grown into one of the country's largest suppliers of high precision, complex, ready-to-assemble precision-turned, milled and ground parts to MNCs in the HDD and digital camera industries.
52 Week High : 3.52
52 Week low : 1.45
As a result of a downward revision in earnings guidance by 34-36% for FY10, negative guidance on Notion's new 2.5" HDD business for FY11 and uncertainty over its 3 antidiscs programs, analyst FY10 and FY11 EPS have been cut by a drastic 40% and 55.5% respectively. The rather high operating and financial leverage nature of the business compounded the drop in earnings revision. Notion only posted earnings of RM3m for 3QFY10 and there may be more negative earnings surprises compared to analyst's FY11 forecast going forward.
Risk Analysis :
1.Mainly weighed down by start-up costs.
The 9MFY10 earnings came in 24% below consensus. The variance was mainly due to high operating costs as R&D, depreciation and amortization, materials as well as labor incurred by the company’s new 2.5” HDD business and strengthening RM against USD and Euro. While 3QFY10 revenue was up by 7% q-o-q and 36% y-o-y, the quarter’s earnings plunged 76% q-o-q and 73% y-o-y. There were also quality issues related to one of its HDD components, which gave rise to rectification and compensation costs.
2.Major production problems.
Orders for antidiscs in one program were stopped following a hydrocarbon contamination problem, which led to the customer cutting orders on the affected component, and the final cleaning of the 2 remaining antidiscs models. Notion has had to outsource to a Singapore vendor at higher cost. Management spent substantial resources in relocating and upgrading the final washing facilities in order to comply with the customer’s requirements. The other production issue involved its 2.5” HDD baseplate project, which has not been performing to expectations, resulting in delays to production targets, excessive start-up costs and high rejection at the die casting and machining stage, as well as rejection by a customer vendor based in Dongguan, China. The project incurred >RM80m capex, which will add to production cost in terms of depreciation and finance cost as it is 80% funded by bank borrowings. Factory 3 is being retrofitted and the manufacturing currently distributed between Factory 1 and 2, and a coating supplier in Banting. This gave rise to cost inefficiency and losses. Management needs time to reorganize the manufacturing for this project. Factory 3 will be operational by Sept 2010.
3. Potential slowdown in the HDD sector.
Price Recommendation :-
Pegging a 7x FY11 PER, which is its historical 5-year average PER, fair value is RM1.45. Currently price is still trading at premium 31% (above its fair value RM1.45).