Our POSITIVE conviction is reaffirmed post a meeting with management, stemming from its superior earnings prospect as well as potential warrant conversion, which could inject cash of up to RM38.6m to the group. While management keeps its lips tight on the plan for cash utilisation (assuming full conversion), we reckon it could be used for further expansion given NOTION’s tight capacity and expansionary track record. While we make no changes to the earnings estimates for now, our TP is raised to RM1.62 (15.5x FY18E PER).

A glaring 1Q17 results. Recall that NOTION registered its 1Q17 with a strong core NP of RM5.4m (-4% QoQ; +206% YoY), with growth drivers from all segments. While results came in within expectation at 26% of our FY17E earnings, positive surprise was the management’s commitment in rewarding investors by forming dividend policy of minimum 30% of PATAMI, to be paid out quarterly. Looking at the operational level, EBIT soared by 108% driven by: (i) better product mixes, (ii) better utilisation of CNC machining as well as (iii) the absence of settlement for adverse currency hedging alongside a low base in 1Q16.

Near-term prospect remains intact. Our OPTIMISM is reaffirmed as we gather that the near-term earning driver, namely the stack-up orders of Automotive EBS components from its new customer are intact. To recap, additional 25 CNC machines (with another 25 upcoming) have been allocated for higher orders from new customer. All in, for Automotive segment, the total volume growth could see a 2-year CAGR of 30% with another 50 CNC machines to be invested next year. For the HDD segment, while the industry is seeing modest growth, management is getting orders from third party machining as well as adoption of helium drive (for nearline enterprise) to supersede industry growth. Meanwhile, the recent news on SSD supply constraint (with HDD as a substitution) is also a short-term booster. Meanwhile, for Engineered products segment, the group has rejigged its portfolio by allocating the capacity in the Camera segment to cater for better margins and higher resiliency products. As reported in the Bursa announcement, these new fatter margin products such as design of tools, jigs and fixtures for customer manufacturing are seeing lights with the emergence of several new customers. All in, the ideal mix for HDD/Engineered Products/Auto is 30%:40%:30% in 2018.

What is more beyond this level for now? Note that the NOTION-WB (1- for-1 Equity Call Warrant with a total outstanding amount of 38.6m warrants and Exercise Price of RM1.00 each) that is poised for expiration on 2nd May 2017, is already In-The-Money. In the Blue-sky scenario, assuming full conversion of 38.6m warrants which could generate cash up to RM38.6m to the group, we reasonably believe that the cash will come in handy for the group to expand into new business. Our assumption is based on: (i) the fact that the group’s Utilisation Rate is already running close at full capacity, (ii) NOTION’s aggressive expansionary mode based on management’s track of record in FY12-16, of consistently venturing different segments to grow its business, (iii) its net cash position which does not require the cash for debt repayment. While we have yet to impute any warrants conversion for now, we reckon the potential cash injection would be utilised for growth opportunities.

Maintain OUTPERFORM with a higher TP of RM1.62 (from RM1.13). Post meeting, while we made no changes to our FY17-18E earnings given the scarcity of details, but we raise our TP to RM1.62 (based on a higher PER of 15.5x, being the group’s up-cycle valuation of +1SD, given its superior earnings prospect as well as 2-year PEG of 0.4x). Maintain OUTPERFORM.

Risks to our call include: (i) slower-than-expected sales/orders thus lower operational efficiency, (ii) higher raw material prices, (iii) unfavourable Trumps’ policy, and (iv) adverse currency fluctuations.

Source: Kenanga Research - 20 Mar 2017