NOTION VTec (34 sen), Malaysia's leading listed manufacturer of precision components for hard-disk drive (HDD) and other industries, posted very strong results for third quarter FY September 2009 (3QFY09) (April-June 2009).

Indeed, its cumulative net profit for the first nine months of RM22.9 million has exceeded our earlier forecast of RM22.5 million for the full year. We now expect net profit of RM33.2 million for FY09, some 48% above our earlier forecast.

Notion posted very strong year-on-year (y-o-y) and quarter-on-quarter (q-o-q) growth in 3QFY09, coming after a weak 2QFY09 (January-March 2009), which marked the worst period for the HDD industry. However, the y-o-y growth in revenue and profitability was also particularly strong — despite a higher base last year. For 3QFY09, revenue rose 38% y-o-y to RM44.7 million, and some 59% higher q-o-q, compared with RM28.2 million in 2QFY09.

Pre-tax profit increased 52% y-o-y to RM12.7 million, more than double 2QFY09's RM5.2 million. Net profit rose 45% y-o-y to RM11.1 million, more than double 2QFY09's RM4.6 million.

For the first nine months of FY09, the company chalked up revenue of RM118.2 million, up 20% y-o-y. Pre-tax profit was 10.6% lower at RM26.5 million while net profit was 4.6% down at RM22.9 million.

The strong growth in 3QFY09 was mainly from the non-HDD sector. Sales of camera components rose 128% q-o-q, and auto components increased 139% q-o-q. This was in part due to a sharp fall-off in sales in 2QFY09 as companies held back on orders.

In contrast, the HDD segment was more resilient throughout the recent crisis, with demand dictated by the need for storage, as opposed to discretionary spending on consumer electronics products. Thus, HDD sales rose only 11% q-o-q, due to its earlier high base. HDD accounted for 42% of the latest quarter's sales, compared with 60% in 2QFY09.

Net debt increased slightly from RM38.9 million in March 2009 to RM42.9 million in June 2009, with gearing at a modest at 27.8%.

Positive earnings outlook

The worst for the HDD sector — and the component manufacturers — was over in the first quarter of the year (Notion's 2QFY09). The recovery in demand is in full swing, as demonstrated by Notion's latest quarterly results, as well as those of its rival Dufu Technology Corp.

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 out, and is on the path to recovery — albeit likely a slow one as there are valid concerns over the strength of the recovery as US consumer spending remains weak amid a poor labour market.

HDD demand has been relatively resilient throughout the global recession, even during the worst quarter when orders for camera parts and other components plunged. Demand is being driven by the need for increased storage for the increasing use of web-based applications.

Nonetheless, within the HDD industry, there are also marked differences in performance between the five major global players, depending on their product, pricing and inventory strategies.

Industry leader Seagate Technology has not fared well compared with Western Digital. Notion is a major supplier to Western Digital, and not to Seagate. Notion is supplying to two players. It has just secured orders from a third, undisclosed player, and will be starting production later this year.

In addition, it is also diversifying and expanding its form factor mix within the HDD segment, from an existing heavy reliance on 3.5" HDDs to the 2.5" sized ones, which are used for laptop and portable applications as opposed to the larger ones for non-portable devices.

Going forward, Notion's orders for the new HDD customer, and diversification into smaller form factor sizes will anchor growth for its HDD segment.

Notion's camera parts business rebounded strongly in the latest quarter, as orders from Nikon resumed in earnest. We understand Notion now accounts for approximately 20% of global cam barrel components, which are used to accentuate SLR camera lenses.

Going forward, Notion will be expanding to Thailand in FY10 via a plant in Ayuthaya, which will cater for increased orders to Nikon Thailand. It will also eventually open up a new customer base there.

Including the plant in Thailand, a nearby plant in Klang and new machinery, Notion will be spending RM50 million on capital expenditure in FY10, on top of RM20 million in FY09. Gearing will remain manageable, with management estimating a peak of around 45%.

The expansion, pipeline of new orders, customers and products will support Notion's growth going forward.

With our earlier full-year forecast for FY09 already exceeded by the nine-month results, we are raising our net profit forecast by 48%, to RM33.2 million. We are raising our FY10 net profit forecast by 40% to RM38.6 million to take into account its pipeline of new orders and expansion.

At 34 sen, its shares are trading at reasonable price-to-earnings (P/E) valuations of 7.2 and 6.2 times FY09-10 earnings, with a decent net dividend yield of 2.9%.

To increase its appeal to institutional investors, Notion also plans to consolidate its shares on a 5-into-1 basis from the existing 10 sen par value into shares of 50 sen par value.

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.


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