PRECISION components manufacturer Notion VTec (RM2.60) recently posted a strong set of final results for FY September 2009 that was ahead of expectations. Notion has been chalking up successive profit growth since FY04, marking its sixth consecutive year of profit growth.

Net profit for FY09 rose 9.4% to RM36 million, 8% above our forecast. This was achieved despite the severe recession in the first half of the financial year. Pre-tax profit increased 5.3% to RM43 million, while turnover rose 18.1% to RM172.6 million.

Full-year earnings per share (EPS) amounted to 25.6 sen after the recently concluded 5-into-1 share consolidation exercise. Notion now has 140.7 million shares of 50 sen par value outstanding.

4QFY09 was another stellar quarter, following on from the strong recovery in 3QFY09 as earnings continued to recover from the weak patch in 2QFY09. Revenue in 4QFY09 rose 14% year-on-year (y-o-y) to RM54.3 million. Pre-tax profit increased 47.5% y-o-y to RM16.5 million while net profit rose 46.7% y-o-y to RM13 million.

Growth in the fourth quarter (4Q) was broad-based. Compared with 3QFY09, sales of camera parts improved by 18% quarter-on-quarter (q-o-q), industrial and automotive parts rose 58% and hard disk drives (HDD) increased 14%. The latest quarter's product mix was 38%: 44%:18% for HDD, camera and industrial components, respectively, as compared with 42%: 46%:12%, respectively in 3QFY09.

Net debt declined from RM42.9 million in June 2009 to RM37.8 million in September 2009, with gearing at a modest 23.1%. A final tax exempt dividend of 2.5 sen per share has been proposed.

Positive outlook
The outlook for Notion is positive. The recovery in demand for its HDD and non-HDD products is in full swing, as demonstrated by its last two quarterly results.

While the outlook for export-oriented companies remains tied to that of the US economy, the world's largest economy has already bottomed out. However, the path to recovery may be a slow one as consumer confidence remains weak amid high unemployment.

The key risk to Notion and export-oriented players will be the strength of the recovery as well as USD-RM exchange rates. Notion derives most of its sales in USD, but will soon derive a large Thai baht denominated income stream when its Thailand operations come onstream (we understand sales will be in baht, but subject to fluctuation within a given baht-USD band).

HDD demand has been relatively resilient throughout the recession, even during the worst period in Notion's 2QFY09 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.

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. The camera segment also continues to see strong demand recovery, mostly from Asia while sales from Europe and the USA are static.

Key growth catalysts
On a more micro level, Notion will see strong growth over the next few years driven by its aggressive expansion programme, especially in Thailand, and a widening of its product range, customers and markets.  

Earnings are poised to grow rapidly driven by the following catalysts:

1) Thailand expansion. Notion will be able to cater more for its biggest client, Nikon Thailand and later, to other multinationals as the country also hosts a large concentration of HDD and auto companies.

2) Increased HDD orders and new products. Notion has secured orders from a new customer, Samsung, and will start production of the 2.5-inch form factor HDD. This opens up Notion to a new customer and market base, as it presently focuses on the 3.5-inch form factor.

The smaller form factor is used for smaller, mobile consumer electronic devices, such as laptops, where demand is growing rapidly.

We understand trial runs are currently being undertaken and production will start in December 2009/January 2010 with targeted monthly sales to reach around RM4 million in June 2010.

3) Over the longer term, Notion is also going into production of more complete components to offer HDD multinationals a more integrated and value-added service and improve on margins.

For a start, it is targeting to produce entire spindle motors, rather than just parts of it. But this will likely be some time away, as it also involves technology acquisition, which the company is working on.

Thailand expansion
Notion VTec is on an aggressive expansion trail — both locally and regionally. The company had earlier proposed to acquire a piece of land with factory in Ayutthaya, just outside Bangkok, Thailand for RM5.05 million, and will be expanding capacity in Thailand and Malaysia.

The Thailand plant measures about five acres and has an existing factory with built-up space of about 23,000 sq ft, which will be eventually expanded to 100,000 sq ft. Notion plans to commence operations in 1Q2010. The plant will be used primarily to support the camera business for Nikon Thailand given its close proximity as well as other industries nearby.

The Thailand operations will enjoy an eight-year tax exemption, which augurs well for Notion's overall effective tax rate. Over time, we would not discount the possibility of the camera operations being moved entirely to Thailand, freeing up the Klang plants for HDD orders.

To fund the Thailand expansion, the company has proposed a 10% private placement exercise, to be placed out to institutional and strategic corporate investors. The share placement proceeds will raise about RM35.5 million and is expected to be completed in December 2009.

In total, Notion will spend about RM70 million on capital expenditure in the next two-three years, in Malaysia and Thailand. This will be easily funded by the private placement and strong operating cashflows.

The company recently ordered over 100 CNC machines, to be delivered from October-December 2009, for both the 2.5-inch and 3.5-inch HDD form factors. Its two plants in Klang are currently operating at full capacity, and the company is considering acquiring further space nearby to cope with rising demand.

Robust earnings growth
Notion's medium-term outlook is positive given the visibility of its new orders and projects, as well as the better macro environment.

We expect net profit to grow 40% to RM50.3 million in FY10. Despite the share placement exercise, EPS will increase by 27% to 32.5 sen. For FY11, we expect net profit to rise 20% to RM60.1 million, or 38.8 sen per share.

The company continued to provide official earnings guidance. It targets FY2010 revenue to be in the range of RM220 to RM240 million with net profit between RM49.5 and RM54 million. Our forecasts are conservatively at the lower end of this range.  

Despite the stock's recent rally, valuations remain attractive, especially relative to its strong growth prospects and excellent track record. At RM2.60, its shares are priced at just 8 and 6.7 times for FY2010-2011.

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.