Stock Name: JCY
Company Name: JCY INTERNATIONAL BERHAD
Research House: OSK
Technology sector
Maintain underweight: Japanese hard disk drive (HDD) component makers, including hard disk media maker Showa Denko (SDK) and HDD-use substrate makers Furukawa Denko and Kobe Steel, have all reported damage to facilities as well as injuries to their employees due to the earthquake and tsunami on March 11.'' Certain facilities have since resumed operations but production volume is likely to be limited due to constraints in electricity, raw materials and fuel supply.
SDK is the world's second largest hard disk media maker by volume behind Western Digital (WD), with about 25% global market share. It fabricates 22 million disks a month with production facilities in Singapore, Taiwan and Japan. Operations at its sites in the Tohoku and Kanto regions were suspended from March 14 to 16.
Certain facilities have since resumed operations but the group says production volumes are likely to be limited for the time being due to various constraints. We understand that SDK is discussing shipment schedules with individual customers, and the potential production shortfall at its plants in Japan would be mitigated by capacity expansion at its Singapore facilities (monthly output to increase 13.6% to 25 million disks).
We do not see significant earnings risks for HDD component manufacturers under our coverage given that major HDD makers such as WD, Seagate and Hitachi (with a combined global market share of 80%) rely mostly on their respective in-house hard disk media production, with each producing approximately 80% to 90% of their own requirements.
Eng Teknologi Sdn Bhd ('neutral', fair value: RM1.73), JCY HDD Technology Sdn Bhd ('neutral', FV: 58 sen) and Notion VTec Bhd ('neutral', FV: RM1.85) all have minimal exposure at less than 7% contribution of their revenue from smaller manufacturers such as Toshiba and Samsung, which typically outsource more than 70% of their hard disk media production to third-party component makers like SDK and Fuji Electric.
Nonetheless, we do not discount the potential downgrade to our earnings forecasts should the disruption prolong as we opine that the top three HDD makers would not have instantly available capacity to absorb the potential shortfall in SDK's hard disk drive media production over the long run.
But disruption at Furukawa Denko and Kobe Steel could prove costly. Furukawa Denko and Kobe Steel together dominate the entire HDD-use aluminum substrate market with a more than 95% global market share. Their substrate plants are located in Tochigi, Japan with Kobe Steel capable of producing 30 million and Furukawa Denko at 20 million units a month. Operations at Kobe Steel's Monka substrate plant have resumed, with management confirming that its facilities sustained no damage although it conceded that production is likely to be affected due to limited electricity supply. Meanwhile, restoration is progressing at Furukawa's plant as damaged equipment is replaced and production facilities repaired.
Given the de facto duopoly posed by these 2 HDD-use substrate manufacturers, we opine that a protracted disruption in production would likely spark an industry-wide substrate shortage, which would lead to lower output for most HDD makers.
The restoration timeline to resume full production remains uncertain at this juncture, but early indications are that the going is more negative end as power supply remains a major concern.
On a relative basis, JCY has the highest earnings downside exposure given its full-fledged HDD component production while its peers Notion Vtec and Engtek have more diversified earnings, with the camera division contributing more than 45% to the former's revenue while the latter's presence in industrial products and original design and contract manufacturing may provide a buffer to any earnings shortfall from its HDD division.
Nonetheless, we maintain our earnings forecasts and valuation basis for now, pending more affirmative indications from'' Japanese manufacturers. Downgrades to our recommendations are likely if operating conditions deteriorate further on a less conducive production environment.
We believe that any potential earnings disappointments in the coming quarters as well as moderating industry growth would continue to dampen sentiment. Manufacturers involved in the semiconductor and HDD industries would have difficulty matching their sales performance in 1Q10, during which they performed remarkably well in a traditionally weak period riding on the economic rebound in 2H09.
Hence, given the lack of a re-rating catalyst over the near term with valuations nowhere near their trough, we reiterate our 'underweight' call on the sector. ' OSK Research, March 24
This article appeared in The Edge Financial Daily, March 25, 2011.
Company Name: JCY INTERNATIONAL BERHAD
Research House: OSK
Technology sector
Maintain underweight: Japanese hard disk drive (HDD) component makers, including hard disk media maker Showa Denko (SDK) and HDD-use substrate makers Furukawa Denko and Kobe Steel, have all reported damage to facilities as well as injuries to their employees due to the earthquake and tsunami on March 11.'' Certain facilities have since resumed operations but production volume is likely to be limited due to constraints in electricity, raw materials and fuel supply.
SDK is the world's second largest hard disk media maker by volume behind Western Digital (WD), with about 25% global market share. It fabricates 22 million disks a month with production facilities in Singapore, Taiwan and Japan. Operations at its sites in the Tohoku and Kanto regions were suspended from March 14 to 16.
Certain facilities have since resumed operations but the group says production volumes are likely to be limited for the time being due to various constraints. We understand that SDK is discussing shipment schedules with individual customers, and the potential production shortfall at its plants in Japan would be mitigated by capacity expansion at its Singapore facilities (monthly output to increase 13.6% to 25 million disks).
We do not see significant earnings risks for HDD component manufacturers under our coverage given that major HDD makers such as WD, Seagate and Hitachi (with a combined global market share of 80%) rely mostly on their respective in-house hard disk media production, with each producing approximately 80% to 90% of their own requirements.
Eng Teknologi Sdn Bhd ('neutral', fair value: RM1.73), JCY HDD Technology Sdn Bhd ('neutral', FV: 58 sen) and Notion VTec Bhd ('neutral', FV: RM1.85) all have minimal exposure at less than 7% contribution of their revenue from smaller manufacturers such as Toshiba and Samsung, which typically outsource more than 70% of their hard disk media production to third-party component makers like SDK and Fuji Electric.
Nonetheless, we do not discount the potential downgrade to our earnings forecasts should the disruption prolong as we opine that the top three HDD makers would not have instantly available capacity to absorb the potential shortfall in SDK's hard disk drive media production over the long run.
But disruption at Furukawa Denko and Kobe Steel could prove costly. Furukawa Denko and Kobe Steel together dominate the entire HDD-use aluminum substrate market with a more than 95% global market share. Their substrate plants are located in Tochigi, Japan with Kobe Steel capable of producing 30 million and Furukawa Denko at 20 million units a month. Operations at Kobe Steel's Monka substrate plant have resumed, with management confirming that its facilities sustained no damage although it conceded that production is likely to be affected due to limited electricity supply. Meanwhile, restoration is progressing at Furukawa's plant as damaged equipment is replaced and production facilities repaired.
Given the de facto duopoly posed by these 2 HDD-use substrate manufacturers, we opine that a protracted disruption in production would likely spark an industry-wide substrate shortage, which would lead to lower output for most HDD makers.
The restoration timeline to resume full production remains uncertain at this juncture, but early indications are that the going is more negative end as power supply remains a major concern.
On a relative basis, JCY has the highest earnings downside exposure given its full-fledged HDD component production while its peers Notion Vtec and Engtek have more diversified earnings, with the camera division contributing more than 45% to the former's revenue while the latter's presence in industrial products and original design and contract manufacturing may provide a buffer to any earnings shortfall from its HDD division.
Nonetheless, we maintain our earnings forecasts and valuation basis for now, pending more affirmative indications from'' Japanese manufacturers. Downgrades to our recommendations are likely if operating conditions deteriorate further on a less conducive production environment.
We believe that any potential earnings disappointments in the coming quarters as well as moderating industry growth would continue to dampen sentiment. Manufacturers involved in the semiconductor and HDD industries would have difficulty matching their sales performance in 1Q10, during which they performed remarkably well in a traditionally weak period riding on the economic rebound in 2H09.
Hence, given the lack of a re-rating catalyst over the near term with valuations nowhere near their trough, we reiterate our 'underweight' call on the sector. ' OSK Research, March 24
This article appeared in The Edge Financial Daily, March 25, 2011.
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