· Benefitting from forex gain. Recently, we revisited JCY International Bhd (JCY), the leading supplier of precision metal components to the Hard Disc Drive (HDD) industry, which have once again reported a strong quarter, in 2Q15 with PATAMI of RM51.2m (+1% QoQ; +34% YoY). Taking a glance at the results, YTD 1H15 headline PATAMI recorded at RM101.3m (+48%), mainly driven by favourable currency translation (strengthening of USD vs. MYR that contributed 26.7% to the YTD NP). Meanwhile, stripping out the forex gain of RM26.9m, the YTD core PATAMI of RM74.4m would have been in line at 51% of consensus’ FY15E NP of RM144.9m.

· Industry dynamics have improved through consolidation. To recap, JCY being a one-stop solution provider for the four key HDD mechanical components, i.e. base plates, top cover assembly, APFA and antidiscs, is the key strategic supplier to Western Digital (c.90% of total revenue) and Seagate (c.10% of total revenue). Over time, the HDD industry has consolidated; from monopolistic competition between seven players in 2006, to now an oligopolistic market structure with only three major players left namely Western Digital (45% of total market share), Seagate (40%) and Toshiba (15%). Since then, ASP of HDD has remained relatively stable with less severe price pressure exerted on the suppliers.

· Striving despite flat HDD shipments outlook. Looking at the macro perspective, total HDD shipment volumes in 2015 are projected to drop by 1.7% to 554.3m after a positive growth seen in 2014 (by a marginal 2.2% underpinned by game console refresh during 1Q-2QCY14). The shipment is expected to fall further by a 5-year CAGR of 2.1% over the long-term on the back of gradually declining desktop PC sales, flattish notebook PC numbers, and continued SSD encroachment, according to Trendfocus report. With persistently tough operating environment and unexciting prospects ahead, we believe JCY with an edge as being 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.

· Seagate in Batu Kawan could benefit JCY. It was reported that Seagate will invest RM1.05bn 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 at nearer proximity to Seagate’s potential new plant (compared to its competitors in China) and its capability as a one-stop integrated supplier, is at the forefront to secure more orders that could expand its revenue share from Seagate.

· Higher automation to address rising wages issue. Note that the current labor costs are hovering at 27% of total Cost of Sales (total COS: c.91% of revenue). In addressing the issue of rising wages, the group has planned a capex of RM200-300m (for more CNC machines) over the next 3-5 years. Headcounts will be reduced from c.19k to c.14k gradually throughout the period, of which according to the management, could save up to RM100m/year in the blue-sky scenario.

· Benefitting from the strong USD vs. MYR trend. Almost 100% of the group’s revenues are denoted in USD with 50% of total costs being the raw material costs (in USD) acting as a natural hedge. Based on the sensitivity analysis stated in the group’s FY2014 annual report, every 10% of strengthening of USD vs MYR would translate into an additional RM50.5m more into the group’s bottomline.

· Not Rated for now at a FV of RM0.79. For illustration purpose, we are projecting FY15E NP of RM148.8m by annualising 1H15E NP of RM74.4m after excluded the forex gains. Note that our projection does not take into account the potential new additional orders from Seagate’s expansion plan in Penang. We value the stock based on an ascribed PER of 11.0x, which is broadly in line with its global peers’ valuations namely WD and Seagate that trade at forward PERs of 11.8x and 10.9x respectively.

Source: Kenanga Research - 2 Jun 2015