PP 7767/09/2010(025354)

9 August 2010

Malaysia Corporate Highlights

RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

B r ief ing Upda te

9 August 2010
MARKET DATELINE

Notion Vtec Share Price

Fair Value
:
:
RM2.04
RM1.54
Limited Visibility Recom : Underperform
(Maintained)

Table 1 : Investment Statistics (NOTION; Code: 0083) Bloomberg: NVB MK

Net Basic FD EPS Net
FYE Revenue Profit EPS FD EPS Growth PER C.EPS* P/CF ROE Gearing GDY
Sep (RMm) (RMm) (sen) (sen) (%) (x) (sen) (x) (%) (x) (%)
2009 172.7 36.0 25.6 25.6 6.6 8.6 - 2.6 24.0 0.2 1.7
2010f 205.8 31.4 20.3 18.7 (20.6) 10.8 30.0 2.5 18.0 0.1 2.2
2011f 250.6 32.4 21.0 19.3 3.1 10.5 37.0 2.2 16.5 0.1 2.2
2012f 311.5 34.8 22.5 20.5 7.4 9.8 42.0 2.0 15.8 0.1 2.2
Main Market Listing / Non-Trustee Stock / Syariah-Approved Stock By The SC * Consensus Based On IBES Estimates

♦ Higher costs. The company’s initial capex of RM80m was to expand

Issued Capital (m shares) 154.6
capacity for the 2.5’’ baseplate capacity to 5m/month in FY9/11 and
Market Cap (RMm) 315.3
7m/month in FY9/12. However, due to higher-than-expected rejected rates, Daily Trading Vol (m shs) 5.2
management now expects to hold production capacity at 2m/month in 52wk Price Range (RM) 3.52–1.48
FY9/11. We believe the excess capacity and operational issues will dampen Major Shareholders: (%)
the earnings outlook in the medium term. Management stated that it will Choo Wing Hong 14.2
review plans for the 2.5” baseplate, and potentially “cut loss” on the project Choo Wing Onn 9.5
within the next nine months. Nikon 9.0

♦ Lost sales due to contamination. Going forward, the company expects FYE Sep FY10 FY11 FY12
EPS chg (%) - - -
lower sales volume from the HDD segment due to loss of one of the anti-
Var to Cons (%) -37.5 -48.0 -51.1
disk supply contracts (ultimately for Western Digital) due to quality issues,
which has affected the company since the 2QFY9/10. However, we note that PE Band Chart
the company will still be supplying for the remaining three anti-disk
programmes. PER = 11x
PER = 8x
PER = 5x
♦ 2.5” baseplate capacity can be used for camera segment ... While
management is committed to making the 2.5” baseplate project work, and
to rectify all quality issues, the company also needs to produce more than
1m/month to break even. Currently Notion is only producing around
400k/month, notwithstanding the high reject rate. Assuming management
is unable to turn the project around within three quarters, management will Relative Performance To FBM KLCI
scrap the project and redeploy the spare capacity from the CNC and die
casting machines to the camera business.
Notion Vtec
♦ … but camera segment margins would then be affected. However, we
note that the camera business is a relatively low volume business, and
FBM KLCI
therefore Notion would have too much machining and die-casting capacity,
which would then eat into the camera segment’s margins. This implies that
the negative impact to earnings could persist beyond three quarters.

♦ Risks to our view. 1) Rise in prices of raw materials; and 2) Fluctuations

in the exchange rate.

♦ Forecasts and recommendation. Management guided for a slower

4QFY9/10 but as we highlighted above, there is still poor visibility on
longer-term earnings. Our forecasts are unchanged and show flattish
growth for FY11-12 but we could still be over-optimistic. Likewise, we warn Yap Huey Chiang
that there could still be downside risk to our fair value of RM1.54 based (603) 92802166
yap.huey.chiang@rhb.com.my
FY9/11 8x FD EPS. We thus reiterate our Underperform call on the stock.

Please read important disclosures at the end of this report. Page 1 of 4

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 9 August 2010

Salient Points From Analysts’ Briefing

♦ Disappointing results explained. Management highlighted key issues in relation to the sharp decline in its
3QFY9/11 earnings. To recap, 9MFY9/10 net profit was below our and consensus expectations, accounting for
71.1% and 55.8% of our full-year and consensus forecast respectively. 3QFY09/10 revenue grew 7.2% qoq and
36.0% yoy but earnings dropped 74.9% qoq and 72.2% yoy.

♦ High reject rates for 2.5” baseplates to blame. The 2.5” HDD baseplate project is the main reason for the
poor results. Together with the company’s ongoing capex of RM80m (of which 80% has been spent) to expand
the 2.5’’ baseplate capacity to 2m/month by end-FY10, the high reject rate of 20-25% has resulted in zero
revenue from the project but significant costs (see Table 2). We understand that the high reject rate was due to
problems during the casting and moulding process. Management now expects the budgeted capex to raise the
production capacity to a maximum of 2m/month in FY11. Note that current capacity for the baseplates stands at
400k/month.

Table 2: Higher Costs in 3QFY09/10

(RMm)
1 Loss from anti-disk 0.45
2 Anti-disk compensation 0.54
3 Additional labour 1.20
4 Levy on foreign labour 0.53
5 R&D 1.30
6 Lubricant change 0.25
7 Maintenance 0.98
8 Depreciation 1.00
9 Effect of foreign exchange 1.95
10 Rental of Plant 3 0.21
11 Finance costs 0.42
Total 8.83
Source: Company

♦ Lost sales due to contamination. Going forward, the company expects lower sales volume from the HDD
segment due to losing one of the anti-disk programmes for contamination. This prompted Notion to outsource the
washing and e-coating process which resulted in additional costs. As highlighted in Table 2, the loss also resulted
in compensation (i.e. to replace the rejects). However, we note that the company will still be running the
remaining three anti-disk programmes.

♦ Limited visibility for HDD. While management now expects lower overall contribution for its HDD segment, we
highlight potentially weaker-than-expected sales volume as we note the less optimistic guidance from major HDD
vendors i.e. Western Digital (WD) and Seagate. In addition, we note that WD reported a US$4 drop in its ASP in
its 2QCY10 results due to more intense competition amongst HDD players. The price competition may persist and
therefore continue to affect Notion’s selling prices.

♦ Final decision on the 2.5” baseplate project by Mar. While management is committed to making the 2.5”
baseplate project work, and to rectify all quality issues, the company also needs to produce more than 1m/month
to break even. Currently Notion is only producing around 400k/month, notwithstanding the high reject rate.
Assuming management is unable to turn the project around within three quarters, management will scrap the
project and redeploy the spare capacity from the CNC and die casting machines to the camera business.

♦ Camera segment margins could be affected. However, we note that the camera business is a relatively low
volume business, and therefore Notion would then have too much machining and die-casting capacity, which
would eat into the camera segment’s margins. This implies that the negative impact to earnings could persist
beyond three quarters.

♦ New orders for the camera segment. Nevertheless, management highlighted it will receive new orders for the
camera segment for its new lens mounting components. We understand the lens mounting would require 12
separate components. Margins are typically higher than for the HDD segment, and hence should contribute
positively to Notion’s earnings. However, volume loading for the component would only commence in FY11.

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 9 August 2010

♦ Capex. Given the negative outlook for the HDD segment, management plans to focus on the camera segment
going forward. The company plans to spend RM30m in FY11 on the business, of which RM20m will be for capacity
expansion for the lens mounting project and RM10m to expand its Thailand plant.

♦ Maintain dividend payout. Despite lower earnings, management plans to maintain its 20% dividend payout for
FY10-12. Based on our forecasts, we estimate operating cashflow of RM55.8-77.9m p.a., which will be able to
cover the payout.

♦ Risks and mitigating factors. We believe Notion’s risks include: 1) Rise in prices of raw materials i.e.
aluminium alloys account for 27% of total costs); and 2) Fluctuations in the exchange rate (90% of revenue is in
USD). In mitigation, we note that the company is focused on: 1) cost-cutting initiatives including in-house tooling
capabilities; and 2) putting into place hedging policies to alleviate the exchange rate volatility.

Forecasts and Recommendation

♦ Forecasts and recommendation maintained. Management guided for a slower 4QFY9/10 but as we
highlighted above, there is still poor visibility on longer-term earnings. Our forecasts are unchanged and show
flattish growth for FY11-12 but we could still be over-optimistic. Likewise, we warn that there could still be
downside risk to our fair value of RM1.54 based FY9/11 8x FD EPS. We thus reiterate our Underperform call on
the stock.

Table 3. Earnings Forecasts Table 4. Forecast Assumptions

FYE Sep (RMm) FY09 FY10F FY11F FY12F FYE Sep FY10F FY11F FY12F
HDD 69.1 82.9 103.6 129.5 Revenue growth (%) 19.2 21.8 24.3
Camera 74.3 90.6 111.4 139.3 HDD 20.0 25.0 25.0
Auto/industrial 29.4 32.3 35.5 42.6 Camera 22.0 23.0 25.0
Turnover 172.7 205.8 250.6 311.5 Auto 10.0 10.0 20.0

EBITDA 63.9 58.6 72.7 84.6 Total Shipments units (m) FY10 FY11 FY12
EBITDA margin (%) 37.0 28.5 29.0 27.2 HDD 36.7 40.9 40.3
Camera 8.8 10.6 12.9
Depreciation (18.2) (19.6) (29.2) (37.7) Auto/others 2.1 2.3 2.9

EBIT 45.7 39.0 43.5 46.9 RM:US$ exchange rate 3.30 3.25 3.20
EBIT margin (%) 26.5 19.0 17.4 15.0
Source: RHBRI estimates
Interest expense (3.7) (4.1) (4.9) (5.4)
Associates 1.0 1.0 0.0 0.0
Pretax profit 43.0 36.0 38.6 41.4
Taxation (7.0) (5.8) (6.2) (6.6)
Minority interest 0.1 0.2 0.0 0.0
Net profit 36.0 31.4 32.4 34.8
Source: Company data, RHBRI estimates

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
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Industry/Sector Ratings

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