Notion Vtec Bhd (July 26, RM2.65)
Maintain buy at RM2.74 with higher target price of RM3.74 (from RM3.63): We hosted a corporate luncheon recently for Notion VTec which was attended by a good crowd of buy-side analysts and fund managers. Management gave some good insights and outlook for the HDD business which will be the main growth driver in the coming years.

We understand from management that due to pricing issues, debt financing will be used instead. Nonetheless, the 1-for-5 free warrants exercise will proceed as planned.

Management believes the 2.5-inch HDD segment is where growth is due to (i) the explosive growth of data, (ii) high growth of external HDDs and (iii) high growth of mobile PCs against desktop PCs.

By year-end, Notion expects capacity for the 2.5-inch HDD components (base plates, spindle motor hubs) to reach two million per month under its first phase. Notion currently produces 400,000 to 500,000 per month for Samsung. Subsequently, the second and third phases will proceed with each phase requiring about six months each for total capacity to reach four million per month and eventually seven million per month. Management hinted that due to political uncertainties in Thailand and the need to oversee the new plant in Klang, any major expansion in the Thai plant will likely be completed only sometime in 2011. Notion is looking to expand floor space from 25,000 to 225,000 sq ft.

Orders for HDD business have been very positive so far though there was a slowdown in June. It is difficult to tell if the slowdown is simply temporary. Also, Notion is working to bring down rejection rates in its new Klang plant from 10% to 12% to 5%. In the interim, margins may be affected.

We raise FY2010/12 EPS forecasts by 3% to 5% to account for (i) the aborted private placement, (ii) higher interest costs, and (iii) dilution from the in-the-money warrants. Hence, we revise our target price from RM3.63 to RM3.74 based on an unchanged PER multiple of nine times on mid FY2010/11 earnings. We are positive that progress in the new Klang plant is on track, and believe once quality issues are ironed out, margins should improve and earnings growth should accelerate.