• MYR3.60 FV based on 20x FY23F P/E. Dufu Technology Corp ought to ride on structural demand growth for big data and cloud storage in the age of digitalisation. Earnings should strengthen in the quarters ahead, sustained by demand for high capacity hard disk drive (HDD), better ASP of titanium spacer, higher loadings, and favourable USD/MYR that should more than offset escalating input costs. Current P/E valuation of 14.6x is attractive for a niche and efficient component supplier to the world’s major HDD players.

• HDD remains relevant in high-capacity storage solutions. HDD capacity shipments grew by 31% YoY to 1.34 zettabytes (ZB) in 2021 thanks to the structural demand growth for data centres, cloud storage, enterprise- hardened infrastructure, and Internet of Things (IoT) devices. The exponential growth in data consumption is expected to spike up demand for high-capacity and nearline storage, such as the newly launched 20TB drives given the lower cost per GB. This, along with the requirement of higher quality material spacer such as titanium (at a higher margin) to ensure the reliability given the proliferation of new HDD technology such as heat- assisted magnetic recording and microwave-assisted magnetic recording are expected to continue drive the demand for the precision components.

• Demand fuelled expansion. In view of the surging demand, we understand that DUFU has almost fully utilised its current capacity, following the expansion of computer numerical control machines and a new factory in Bukit Minyak Industrial Park for sheet metal and structure fabrication back in 2019-2020. Construction of its 37k sqm (double the space of current facilities) new factory is now underway, and operations should commence in 2H23. The expansion of this second manufacturing facility in China is to support its key customer’s business continuity plan and cope with surging demand, and new product development from potential prospects.

• Growing metal sheet business. DUFU’s sheet metal division continues to strengthen, in tandem with the upcycle for the semiconductor market and EMS sector and the robustness of the entire electrical & electronics (E&E) ecosystem in Penang. The new plant, which commenced operations since 2H19, has been yielding positive results and is well-positioned to tap into more business opportunities in the automotive, medical, and semiconductor segments. The onboarding of two new key multi-national customers and strong industry demand should propel the segment to greater heights.

• Fair value. We derive a fair value of MYR3.60, based on a target P/E of 20x on FY23F earnings, supported by a 3-year CAGR of 17.4%, buoyed by the mid-term structural growth trend and superior ROE of c.25%. The target valuation is on par with its 5-year average trailing P/E for Dufu and is at a discount to the technology sector. Besides, earnings growth will sustain into FY22F-23F attributed to the overall industry landscape, client stickiness, engineering know-how and operating efficiency.

• Key risks: Unfavourable FX rates, order fluctuation, labour shortage and escalation of input costs.

Source: RHB Research - 18 Jul 2022