15 March 2010
New Coverage
MARKET DATELINE
15 March 2010
♦ Global Supplier. Notion Vtec Berhad (Notion) supplies high precision Issued Capital (m shares) 154.6
components to the world’s biggest manufacturers such as Western Digital, Market Cap (RMm) 462.1
Seagate, Hitachi, Nikon, and Continental. The company drives on Daily Trading Vol (m shs) 299.5
52wk Price Range (RM) 3.52–0.80
technology-based equipment. The company has 3 main business
Major Shareholders: (%)
segments: 1) hard disk drives (HDD); 2) Camera; and 3) Auto &
Choo Wing Hong 14.2
Industrial.
Nikon 10.0
♦ Strategic partner with the second-largest maker of SLR. Recall that Choo Wing Onn 9.5
♦ New impetus: Samsung. Notion is expected to produce 2.5’’ base plates PER = 14x
PER = 11x
components extensively with initial production of 100K units per/month PER = 8x
rising sharply to 1m units per/month by June and 2m pieces per/month
by end 2010. Although orders for the higher-margin spindle motor hub
are currently in smaller scale, we expect this to grow significantly in
FY11-12 as Notion steps-up its capability to produce higher-value
components. Management expects Samsung to be a key customer
beginning FY10 given volume loading of 2.5’’ base plates as well as Relative Performance To FBM KLCI
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♦ Background. Notion Vtec (Notion) is an integrated precision engineering specialist and tools maker. The
company has since diversified its production into three main areas; hard disk drive (HDD), digital single-lens
reflex (DSLR) camera and interchangeable lens components, and industrial parts.
♦ Started 15 years ago. Notion began as a family business with four computer numerical control (CNC) machines
and 2K sq ft of floor space, initially to supply automotive & air conditioner sintered parts. The company started
manufacturing HDD components in 1997 and the business took off in 2002 when it was approved as a certified
vendor for Western Digital, in the same year it qualified as a camera component supplier to Canon. In 2006,
Notion started producing DSLR components for Nikon and is now an approved vendor for Nikon and Canon.
Notion was listed on the Mesdaq market in 2005 and later to the Main Market in 2008. Currently, the company is
equipped with 1,100 CNCs with 1,500 employees in two production facilities (Klang and Ayuthaya, Thailand).
Table 2: Subsidiaries
Company Shareholding Principal Activities
%
Notion Venture 100 HDD, camera, consumer electronic & automotive components
Autic Mekki Electrolyses nickel plating
Intech Precision 100 Precision jigs & fixtures, tools & dies, gauges
NV Technology 100 Custom cutting tool, marketing of abrasive products i.e. Polycrystalline Cubic
Boron Nitride (PCBN) inserts
Diaphragm Tech 100 Air chuck assembly system for soft clamping, tool-holders, lathe chucks for use
by CNC machining
Kaiten Precision 90 High precision micro parts
Source: Company
Outlook
♦ Global HDD shipments to jump 11-12% in 2010-2012. According to Trendfocus, global HDD unit shipments
are expected to reach 771.3m in 2012 (vs. 694.65m in 2009) driven mainly by the growing demand in mobile
computing and consumer electronics (CE).
♦ The demand for 2.5’’HDD is set to be the key driving force in mobile computing. Given stronger sales
for notebooks and mobile computing, we expect demand for smaller form factor 2.5’’ HDD (vs. 3.5’’ HDD for
desktop) to pick up momentum going forward. Trendfocus forecasts the notebook market to reach a CAGR of
21.2% for 2009-2012, which would account for more than three-quarters of PC shipments in three years.
♦ CE industry. With technological advancement and more affordable pricing for HDDs, we understand CE
producers are beginning to roll out TVs and DVD players with memory storage capability. We understand that
unit shipments in 2008 of CE HDD have more than doubled since 2004 and are expected to maintain double-
digit growth in 2011.
Chart 1: Global HDD Unit Shipments (m) Chart 2: Global 2.5'' HDD Shipments (m)
771.3 518.2
694.65
624.81 427.45
540.28 555.6
501.88 345.36
435.45
379.98 267.9
222.97
173.18
122.01
83.65
2005 2006 2007 2008 2009 2010f 2011f 2012f 2005 2006 2007 2008 2009 2010f 2011f 2012f
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Samsung Others
8% 1%
Seagate
Toshiba
31%
16%
HGST
17%
WD
27%
Source: Trendfocus
♦ A vendor for WD, world’s second largest HDD producer, we highlight that Notion supplies approximately
30% of anti disk, 30% of disk clamps and 17% of spacer rings of Western Digital (WD) requirements. In FY09,
this contributed to 35-40% of total revenue. We highlight that WD achieved record shipments in 4QFY09,
indicating a sustainable growth in 2010. WD’s shipments rose 12.2% qoq to 49.5m units driven by strong
demand for 3.5’’ and 2.5” HDD as well as stronger-than-expected market share gains in the enterprise HDD
segment stemming from stronger IT spending as well as consumer electronics demand. With demand outlook
remaining robust and capacity expected to remain tight till end-2010, WD expects unit shipments to register
strong double-digit growth. As such, the company has raised its 2010 capex guidance to US$650-750m (from
US$650m previously).
♦ Samsung to provide new impetus. Notion is expected to produce 2.5’’ base plates components extensively
with initial production of 100K units per/month rising sharply to 1m units per/month (by June) and 2m pieces
per/month by end-2010 respectively. Although orders for the higher-margin spindle motor hub are currently
smaller scale, we expect this to grow significantly in FY11-12 as Notion steps-up its capability to produce higher-
value components. Management expects Samsung to be a key customer beginning FY10 given volume loading of
2.5’’ base plates as well as production ramping of higher margin spindle motor hub. We project Samsung’s
revenue contribution of 10% to rise to 15% in FY11 and 20% in FY12.
WD HGST Samsung
Desktop 3.5’’
Enterprise 3.5’’
Enterprise 2.5’’
Notebook 2.5’’
Notebook <1.8’’
CE 3.5’’
CE 2.5’’
CE <1.8’’
Source: Trendfocus
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♦ HDD revenue to grow 40% yoy in 2010. We expect the HDD segment to be the main revenue contribution
accounting for 45-47% (vs. 43% and 44% in FY08 and FY09 respectively). We expect FY11-12 revenue growth of
30% and 25% respectively driven mainly by; 1) robust order from Samsung and WD; and 2) stronger global HDD
demand stemming from rising PC and CE sales.
CAMERA SEGMENT
Outlook
♦ Robust growth in SLR & interchangeable lens shipments. According to Camera & Imaging Products
Association (CIPA), while total shipments of digital cameras in 2009 fell by 11.6% yoy mainly due to the decrease
in shipments of standard digital cameras, shipments for the SLR cameras with interchangeable lens recorded an
increase of 2.3% yoy and shipments of interchangeable lenses reached 16.1m units, rising 2.8% yoy. Note that
CIPA forecasts 2010 total shipment of standard digital cameras, SLR cameras, and interchangeable lenses to
increase by 3.0%, 11.1% and 11.2% respectively.
Interchangable lens for SLR cameras (m units) SLR for Interchangeabl e l ens (m uni ts)
12
19 11
18 10
16 10
16
13 7
5
9
7 4
5 2
2004 2005 2006 2007 2008 2009 2010F 2011F 2004 2005 2006 2007 2008 2009 2010F 2011F
Source: CIPA
Pentax Others
Olympus 6%
2%
4%
Sony
8%
Canon
47%
Nikon
33%
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♦ Strategic partner with the second-largest maker of SLR. Recall that Nikon acquired a 8.98% via a private
placement exercise which raised about RM33.8m. The proceeds will be used for the purchase of CNC machines
and working capital for its plant Ayuthaya, Thailand. Notion plans to expand its Thai plant’s floor space of 25K sq
ft with the plan to expand it further to 225K sq ft by end-2010. Accordingly, the company would increase its CNC
machines to 500 units (from 100 units currently).
♦ Riding on Nikon’s growth. Nikon expects 10% growth of its digital SLR camera sales to be driven mainly by
strong demand from Asia and emerging markets. In the longer term, Nikon expects revenue contribution from
the camera division to grow significantly given stronger-than-expected demand for cameras and growing camera-
related services due to strong demand in emerging markets. While Nikon only currently contributes about 25-
30% of revenue, we expect Notion to further develop its expertise and technical know-how in order to service
Nikon which will further improve production efficiently. We also note that Nikon is in the process of outsourcing
50% of its components, and therefore revenue from Nikon is expected to increase by 35-40% (vs. 30% in FY09).
♦ Additional boost from Canon. In tandem, Canon also forecasts a strong recovery in 2010 with net profit to
double in 2010. The company plans to boost its capacity in Thailand given stronger demand for its digital cameras
in South East Asia. While Canon contributed only 10% of Notion’s revenue in FY09, mainly from its operations in
Malaysia, we believe Notion could also ride on Canon’s Thailand expansion plans going forward. Note that Nikon
has not been given a board seat in Notion, thus mitigating the risk of loss of business from rival camera
manufacturers.
♦ Camera segment to eventually lead revenue growth. We forecast sales for the camera segment to grow by
25%, 37%, and 40% in FY10, FY11, and FY12 respectively given volume loadings from Nikon. Also, we believe
this segment will eventually overtake HDD’s revenue contribution in 2012 due to: 1) higher volume growth for
cameras given volume loadings from Nikon; and 2) camera ASP to remain stable, supported by a growing
proportion of camera barrel lens that are more complex. We highlight that camera margins are significantly
higher than HDD i.e. 45% vs. 30% given higher levels of customisation and value-added services for camera
products.
Auto/Industrial
♦ Producer for EBS. We understand that electronic braking systems (EBS) are gaining popularity in the
automotive industry as technology advancement has reduced overall cost without compensating performance.
Notion manufactures components to JVC, PMG, and Continental for the automotive and industrial segment. This
segment remains the smallest revenue contributor, i.e. 10% of total revenue with the bulk of components
distributed to Continental (representing 20% of Continental’s requirements). We expect strong demand for EBS
given greater adoption of EBS in the mass-market segment (vs. high-end models previously).
♦ Revenue contribution to remain at 10%. While the earnings in this segment are closely tied to the global
auto industry outlook, medium-term earnings growth remains bright as Notion is on the verge of securing
sizeable contracts from TRW (the world’s second-largest producer of auto safe components) and Valeo.
♦ Capex. The company plans to spend more than RM100m of capex for FY10-12 of which RM77m would be for its
Malaysian expansion and the balance for its Thailand operations. Management is also looking at a third factory of
about 150K sq ft of floor space which is expected to be in operation by 2H2010. In addition, there are plans for
further expansion into Southern China to service Samsung’s strong orders as early as 2011.
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• Fluctuations in the price of raw material. In general, rising aluminium price pose a threat to HDD
fabrication margins given the significant amount of aluminium alloy used for HDD components. According to
management, aluminium costs account for 16% of total costs. Nevertheless, this is partly mitigated by
Notion’s effective cost-cutting measures and roll-out of higher-margin products. We estimate that a 10% hike
of price of aluminium would reduce Notion’s earnings by 7-8%.
• Threat of solid state drives (SSD). SSD is said to be the future of data storage with new CE such as tablet
PCs and smart phones, especially for smaller form factor devices. However, we do not believe SSD will
overtake HDD for products where size is not the determining factor given the still huge price differentiation.
Note that the premium per GB of SSD computing applications is 15-20x the cost per GB of HDDs in 2009.
• Foreign exchange fluctuations. Notion’s revenue is mostly denominated in US$. The main raw material in
the manufacture of HDD components and camera barrels is aluminium. We estimate 1% appreciation of RM
against US$ would reduce Notion’s earnings by 2%.
• Competition to intensify. We expect competition in the HDD component industry to increase as producers
expand market share within HDD vendors. However, unlike other pure HDD component manufacturers, 45%
of Notion’s revenue is derived from the camera business.
♦ The tool maker. An important aspect we like about Notion is the in-house cutting tools R&D. Notion puts
emphasis to develop its own cutting tools, ultimately to reduce the machinery costs vs. purchasing expensive tool
and die sets. Furthermore, we believe the in-house capability contributes to shorter turnaround time for new
products vis-à-vis its competitors.
♦ Dividend policy. Notion has not indicated any dividend policy but it is likely to maintain its minimum 20%
payout of net profits. We forecast FY10-12 dividend payment of 20% as dividend payout would be capped by high
capex spending for the next three years.
♦ Potential acquisition target. Notion has a healthy balance sheet giving rise to the possibility of M&A
opportunities and business tie-ups for further expansion and development. In addition, given its expertise in the
production of camera components, we believe Notion may be a potential acquisition target by highly concentrated
and large industry players that are seeking to diversify their earnings base.
Earnings Assumptions
♦ Forecasts. We estimate net profit to grow by 34-37% p.a. in FY10, FY11, and FY12 respectively driven mainly
by: 1) stronger demand in the 2.5’’ HDD segment particularly the robust orders from Samsung; and 2) stronger
contribution from its camera division given volume loading from Nikon. We expect FY10-12 EBITDA margins of
around 37% p.a. supported by 1) stronger contribution of higher-margin camera segment; 2) continuous stable
HDD ASP; and 3) cost-cutting measures via efficient in-house tooling capability. Furthermore, we highlight the
potential upside to our FY11-12 earnings driven mainly by; 1) higher-than-expected sales of higher margin
spindle motor and camera barrels; and 2) stronger contribution from its Thailand operations stemming from
expansion of WD and HGST in Thailand.
♦ Valuations. We estimate FY10-12 EPS CAGR of 34.6% on good earnings for the next 24 months given the strong
demand outlook for all business segments. We have derived a target PER of 10x which implies a 29% discount to
the peers’ weighted average FY11 PER of 14x as historically the share has been trading at these levels. Therefore,
we estimate a fair value of RM 4.59 based on 10x FY11 EPS. We thus initiate coverage on Notion with an
Outperform recommendation.
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(US$) (x)
Cost of sales (112.4) (141.1) (186.4) (241.2) Gross profit margin (%) 36.7 36.9 37.3
HDD 30.0 30.0 30.0
EBITDA 64.3 86.5 114.3 150.3 Camera 45.0 45.0 45.0
EBITDA margin (%) 37.2 38.8 38.7 39.1 Auto/others 31.0 31.0 30.0
Depreciation (18.2) (22.2) (26.9) (32.7) RM:US$ exchange rate 3.30 3.25 3.20
Appendix
Description of products
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Image of Products:
Picture 3: Anti-disk
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IMPORTANT DISCLOSURES
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Stock Ratings
Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.
Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or more over
a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take on higher risks.
Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.
Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.
Industry/Sector Ratings
Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.
Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.
Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.
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