JCY International Bhd
(June 2, 73 sen)
Not rated with a fair value (FV) of 79 sen: Recently, we revisited JCY International, the leading supplier of precision metal components to the hard disc drive (HDD) industry, which has once again reported a strong quarter in the second quarter of financial year 2015 ending September (2QFY15) with profit after tax and minority interest (Patami) of RM51.2 million (up 1% quarter-on-quarter [q-o-q]; up 34% year-on-year [y-o-y]). 

Taking a glance at the results, year-to-date (YTD) first-half (1HFY15) headline Patami came in at RM101.3 million (up 48%), mainly driven by favourable currency translation (strengthening of the US dollar against the ringgit that contributed 26.7% to the YTD net profit). 

Meanwhile, stripping out the foreign exchange (forex) gain of RM26.9 million, the YTD core Patami of RM74.4 million would have been in line at 51% of consensus’ FY15 estimated  net profit of RM144.9 million.

To recap, JCY being a one-stop solution provider for the four key HDD mechanical components — base plates, top cover assembly, actuator pivot flex assembly and antidiscs — is the key strategic supplier to Western Digital (about 90% of total revenue) and Seagate (about 10% of total revenue). 

Over time, the HDD industry has consolidated; from monopolistic competition between seven players in 2006 to an oligopolistic market structure now with only three major players left — Western Digital (45% of total market share), Seagate (40%) and Toshiba (15%). Since then, average sales price of HDD has remained relatively stable with less severe price pressure exerted on the suppliers.

Looking at the macro perspective, total HDD shipment volumes in 2015 are projected to drop by 1.7% to 554.3 million after positive growth seen in 2014. Shipments are expected to fall further by a five-year compound annual growth rate of 2.1% over the long term on the back of gradually declining desktop personal computer (PC) sales, flattish notebook PC numbers, and continued solid-state drive encroachment, according to online market analyst Trendfocus reports. 

With a persistently tough operating environment and unexciting prospects ahead, we believe JCY has an edge as the only integrated supplier with a meaningful market share for its four key HDD mechanical components, could stand well to benefit at the expense of other HDD components manufacturers which are struggling financially and operationally.

It was reported that Seagate will invest RM1.05 billion to build a new HDD plant at the Batu Kawan Industrial Park in Penang. Although not much detail was available given the infancy stage of development, we believe JCY, which is geographically closer to Seagate’s potential new plant (compared with its competitors in China) and with its capability as a one-stop integrated supplier, is at the forefront to secure more orders that could expand its revenue share from Seagate.

Note that the current labour costs are hovering at 27% of total cost of sales. In addressing the issue of rising wages, the group has planned capital expenditure of RM200 million to RM300 million over the next three to five years. Headcounts will be reduced from about 19,000 to 14,000 gradually throughout the period which, according to management, could save up to RM100 million a year in a blue-sky scenario.

Almost 100% of the group’s revenue is denoted in US dollars with 50% of total costs being the raw material costs (in US dollars) acting as a natural hedge. 

Based on the sensitivity analysis stated in the group’s FY14 annual report, every 10% of strengthening of the greenback against the ringgit would translate into an additional RM50.5 million into the group’s bottom line.

The counter is “not rated” for now at a FV of  79 sen. For illustration purposes, we are projecting an estimated net profit of RM148.8 million for FY15 by annualising 1H estimated net profit of RM74.4 million after excluding the forex gains. Note that our projection does not take into account the potential additional orders from Seagate’s expansion plan in Penang.

We value the stock based on an ascribed price-earnings ratio (PER) of 11 times, which is broadly in line with its global peers’ (Western Digital and Seagate) valuations  that trade at forward PERs of 11.8 times and 10.9 times respectively. — Kenanga Research, June 2

This article first appeared in The Edge Financial Daily, on June 3, 2015.