Technology stocks, it seems, are sexy again. Some of these gains are due to renewed interest in so-called “rotational plays” by investors with the stomach for higher risk, who are betting on a revival of consumer demand as economic activity picks up.

Just two weeks into 2010, the Kuala Lumpur Technology Index is up some 27%, outperforming the 2% to 7% charted by other sector-based indices year-to-date, as well as the 3% gain at the broader FTSE Bursa Malaysia Emas Index over the same period.

Similarly, in just a fortnight, KL Tech index heavyweights Unisem (M) Bhd and Malaysian Pacific Industries Bhd (MPI) are up 43.3% and 31% at their respective closing prices of RM2.35 and RM7.01 last Thursday. If CIMB Research is right about what Unisem and MPI are worth, there is a further 15% to 16% gain to their respective target prices of RM2.70 and RM8.16.

Driven by its plant in Chengdu, China, Unisem expects 2010 to be the best year yet for both its top and bottom lines, “a stark departure” from 2009, when the main emphasis was on cost-cutting, CIMB says. MPI, which last year concentrated on cash preservation and balance-sheet management, has also turned more aggressive, planning to boost its multi-leaded package (MLP) capacity by 25% in Ipoh and 27% to 28% in Suzhou to increase revenue. MPI, whose share price last Thursday closed above RM7 for the first time in 15 months, is also considering the acquisition of a similar-sized test and assembly arm of an integrated device manufacturer.

Encouraged by the gains seen at Unisem and MPI, investors had also chased higher the stock price of another “old technology stock” — Globetronics Technology Bhd, which makes and assembles integrated circuits. Closing at RM1.09 last Thursday, the counter has gained 40% over two weeks. Globetronics is hoping to achieve some 25% to 30% growth in its top and bottom lines, fuelled in part by volume expansion as well as the acquisition of new customers, CIMB says.

Apart from these three relatively “old names” in the tech sector, investors may want to consider alternatives in companies serving the hard-disk drive (HDD) industry. After all, the impending IPO of JCY International Bhd is expected to put the spotlight on industry peers.

JCY, one of the world’s largest manufacturers of HDD mechanical components in terms of revenue and production volume, sells most of its products to Seagate Technology and Western Digital Corp, the world’s largest and second-largest HDD makers, both of which recently reported sales and profits that topped analysts’ estimates.

Western Digital and Seagate also contribute, for instance, about 70% of the revenue of HDD component maker Eng Teknologi Holdings Bhd (EngTek). Affin Investment Research, for one, reckons sentiments on EngTek have been lifted by JCY’s upcoming listing. In a Dec 30 note, Affin valued EngTek’s stock at RM2.47, based on its historical mean price-to-book ratio of 1.2 times, and implies 8.5 times FY2010 earnings. At the time, EngTek’s shares were going for RM1.52 apiece.

“Although JCY’s IPO price has yet to be established, the indicative market capitalisation of RM2 billion implies (a valuation of) 9.7 times earnings based on FY9/2009 net profit of RM207 million. EngTek’s FY2009 price-to-earnings ratio of 5.3 times is therefore cheap, although we would qualify that JCY is significantly larger in terms of operations. (For FY2009, revenue for JCY stood at RM1.8 billion, compared to EngTek’s RM467 million),” Affin said.

EngTek has since appreciated, closing at RM1.99 last Thursday, up 34.37% year-to-date. In its Jan 13 note, CIMB says EngTek is targeting 10% to 15% top-line growth and 20% growth in pre-tax profit for FY2010, fuelled primarily by its main clients as well as “the ramp-up of the supply of actuators to a new customer throughout much of 2010”.

Similarly, DSC Solutions Bhd, which made its debut on the ACE Market on Dec 9, garnered an average of 32.4% of its revenue over the past three years from selling automatic identification and data collection (AIDC) solutions to Seagate. DSC closed at 32 sen last Thursday, up 28% from its (bonus-issue-adjusted) IPO price of 25 sen.

Then there’s Dufu Technology Bhd and its rival Notion VTEC Bhd — both relatively lesser-known Main Board-listed tech stocks, whose strong 3Q2009 results were seen as a testament to the HDD industry’s resilience. Both Dufu and Notion VTEC make components for HDD, while the latter also makes components for single-lens reflex (SLR) cameras.

Closing at RM3.32 last Thursday, Notion VTEC is up 22% in eight trading days and would be trading at 10.2 times Asia Analytica Sdn Bhd (InsiderAsia)’s estimated earnings for FY2010 and 8.56 times estimated earnings for FY2011.

At this level, Notion VTEC shares have run ahead of Kenanga Research’s RM3.27 target price for the stock. Kenanga, which has the highest target price for Notion VTEC, according to Bloomberg data, had just raised the target price from RM3.16 to RM3.27. This was after ascribing a higher earnings multiple of 10 times (from nine) to the company’s FY2010 earnings, citing synergies from the potential entry of a new strategic shareholder as well as the impending listing of JCY, according to a Jan 7 note.

On Jan 6, Notion VTEC said it would be placing out 13.8 million shares (about 9% stake) for RM33.8 million, or RM2.44 apiece, to “a strategic corporate investor” by Jan 20. This investor has not been named at press time.

“We gather from the industry that the (investor) will likely be a major camera manufacturer, which will provide much synergy to the group. Currently, Notion’s key camera customer is Nikon, which has about 40% market share of the high-end DLSR market. It would be a strong testimony to the group’s capability in terms of quality and delivery should the speculation come true,” Kenanga said in its note.

OSK Research has a RM2.98 target price for Notion VTEC, while Standard & Poor’s was RM2.90 as at Nov 11, according to Bloomberg data.

In the case of its rival, Dufu, investors continued to chase the latter’s stock price higher, even when Standard & Poor’s had a “neutral” recommendation, with a 47 sen target price (six times FY2010 earnings), according to a Nov 10 note. Dufu had run-up as high as 73 sen intra-day on Jan 12 and, at its 61.5 sen close last Thursday, Dufu is up 43% over eight trading days. At 61.5 sen, Dufu was trading at 8.7 times Asia Analytica’s 7.1 sen FY2010 earnings estimate for the company and below its book value of 68 sen.

Going forward, there may well be further re-rating catalysts, should tech companies continue to deliver on earnings or beat expectations. And the fourth quarter is traditionally the strongest for HDD component players, due to increasing production ahead of Christmas.
Tech stocks gained in Asia last Thursday after chip-giant Intel said its 4Q earnings surged nearly 10-fold y-o-y as revenue rose 28%, significantly above street expectations.

Still, given the recent run-up in share price, one would soon need to ask how much upside is left for these stocks.

Some investors may find comfort in the fact that the stretch of m-o-m chip-sales growth that began from the 3.3% recorded in March 2009 “has yet to end”. When upgrading the semiconductor sector to “overweight” from a “trading buy” last Wednesday, CIMB pointed out that it was in March last year that the tech sector saw its turning point. In retrospect, chip sales were still down 27% q-o-q in 1Q2009, a second straight quarter of contraction. But industry experts are now forecasting a strong double-digit rebound in sales for 2010 after the decline in 2008 and 2009.

“Fundamentals are improving as the demand equation is set to swing closer to equilibrium; the global economy is gradually reviving; the key end-user markets are forecasting stronger growth; inventory in the industry is tight; and a potential corporate replacement cycle may kick in… On top of that, many chip firms have been cutting costs aggressively, meaning that they will emerge much leaner from the tumultuous 2009,” says CIMB.

But have all these positives been priced in? After all, history has shown that investors have no qualms about dropping tech stocks should there be reason to once again run for cover in the more stable but “boring” dividend plays.

This article appeared in Corporate page, The Edge Malaysia, Issue 789, Jan 18-24, 2010