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Tuesday, April 25, 2006

Seksun @ 38 cts ( Hard Disk / Singapore ) 4 comments

Final Poll Results: 2:3

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Main issues

1.Recovery is not really emphatic

2.Its computer peripherals growth may be weak

3.Rising raw material costs

Seksun is a fundamentally ok stock, that I acknowledge. No debt, clean balance sheet, respectable cash flow, good dividends every year. That was what propelled it to above $1 in late 2003 (pre- 2-for-1 split) and prompted brokers to call it a value stock. Fundamentals-driven investors may be looking at it.

That is one reason why I write about it now. It is the value trap; there is always a place for value in the stock market but where growth drivers and good prospects for the core business are lacking the stock may languish; high opportunity costs are incurred in a secular bull market such as this (despite recent market corrections).

Let's consider its revenue base and its profit margins over the years to get an idea of the growth potential of the company.

The company's core business, manufacturing of high-precision metal components for hard disk drive OEMs, has been stagnant in terms of revenue for the past 2-3 years. It supplies top covers and VCM (voice coil motor) plates to its main customers Seagate and Hitachi/IBM. Revenue base has been ranging around the S$150-200M range from FY01 to FY04; one should not be deceived by the FY05 revenue of >S$200M because ~S$40M of this growth was contributed by the Telecommunication equipment segment which has nothing to do with HDDs. Pre-tax profit margins peaked at ~15% in FY03; it declined to <10% in FY04 on the back of over-supply in the HDD industry, but the industry-wide recovery in FY05, phenomenal for other components companies like the two Ms --- MMI and Magnecomp, was rather muted in Seksun's case. To be fair, we take away its non-core subsidiary losses (Harvests Multimedia and Seksun Array) of total S$3.7M)--> pre-tax profit = S$17M, and assume core business revenue is ~S$150M (Computer peripherals segment + Consumer electronics segment), the pre-tax margin is ~11%, or only about 2 percentage points higher than its FY04 bottom.

If one studies the FY05 segmental revenue performance, it is clear that the computer peripherals segment is likely to stagnate further (<5% revenue growth), while any growth must come from the consumer electronics segment which experienced high revenue growth. Although some of this was probably contributed by Harvests Multimedia (which was an ODM for DVD recorders), its revenue contribution was probably not significant. Adding back the loss of S$2.5M incurred by Harvests, the consumer electronics segment actually doubled its profits in FY05. This is in agreement with the well-documented surge in consumer electronics HDDs, but one must remember that (1)this growth was from a low base and (2)outlook for consumer electronics HDDs may be softer as flash memory prices have dropped rapidly and become competitive as an alternative (think about Apple replacing HDDs with flash in its new Ipods)

Consider the costs. Raw materials constitute ~60-70% of revenue and metals (steel and aluminium) are the main raw material. Aluminum prices are surging, while for steel, since the sharp drop in steel prices last year, they have since corrected strongly (you only have to look at HG Metal shareholders' insider buying, to deduce that). That is going to constitute margin pressure.

Consider peers' near-term performance projections. I would consider MMI and Magnecomp strategic suppliers to the top HDD OEMs. The former undertakes work across the entire process chain, from designing/manufacturing the production and test systems for its HDD customer, to manufacturing the HDD components, to assembling them; the latter is the world's second largest manufacturer of suspension assemblies, a crucial component in HDDs. MMI has projected margin pressure due to raw materials costs, while Magnecomp's chief rival Hutchinson Technology has released a poor set of results recently. It will also be worth noting that another peer, Cheung Woh, issued a profit warning recently.

On the various fronts (revenue, costs, peer projections) the near to medium term performance looks muted, if not gloomy. Two additional points to raise: firstly, one should not count on its other businesses to drive growth, since its contract manufacturing arm Seksun Array was still bleeding red ink in FY05; Harvests Multimedia was wound down; and only its flexible PCBA work is promising, albeit still minor in profit contribution; secondly, the much-publicised consolidation of Seagate and Maxtor may not be beneficial to Seagate although it is an incumbent supplier to Seagate. That's because I do not consider Seksun a strategic supplier in the way MMI or Magnecomp are, looking at the muted revenue growth over the years. Indeed, without being overly alarmist, one of the more likely possibilities is that there might be bargaining pressure from a now larger and dominant Seagate.

So what if it is trading close to NTA (35 cents)? Unexciting prospects are likely to make this a laggard.




Anonymous Anonymous said...

i do not agree with your comments. 2Q result just released. revenue growth with margins expansion. market share gains, higher volume post Seagate-Maxtor merger and turnaround in EMS business ... all looking good

8/13/2006 3:26 PM  
Blogger DanielXX said...

Well, looks like it may be worth a punt :-)

8/13/2006 6:39 PM  
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