* Business for all segments remained strong thus far. Our discussions with management suggest that things are still going well for the company. Demand for all product segments was robust, especially going into the September quarter. Average utilisation rate for the group improved from 70-75% in the June quarter to about 80% currently.
* Margin pressure from higher material costs and weaker US$ as expected. According to First Engineering (FE), margin was affected by the two above-mentioned factors in the June quarter. However, margin is expected to improve in the September quarter on the back of better utilisation, tight cost control, and greater economies of scale.
* Forecast tweaked, but Outperform rating maintained. We raised FY07-09 sales projection but our profit forecasts remain relatively unchanged due to our downward revision of margin assumptions. We deem FE attractive at 5.6x CY06 P/E vs. its historical average forward P/E of 11x. However, we lowered our target price from S$1.37 to S$1.10, using 8x CY06 earnings instead of 10x in view of the P/E compression for plastic injection molding companies, and its slower EPS growth in FY07. Maintain Outperform for its steady earnings growth, healthy ROEs, and undemanding valuations vis-à-vis industry peers.
Outlook
Business for all segments remained strong thus far. Our latest discussions with management suggest that things are still going well for the company, and demand for all product segments remained robust, especially going into the September quarter. Average utilisation rate for the group improved from 70-75% in the June quarter to about 80% currently. Based on customers’ current projection, outlook for the December quarter remains positive.
Business machine segment, which formed 37% of group revenue in FY06, continued to enjoy healthy growth on the back of customer’s organic growth (HP’s posted 15% yoy unit shipments growth during May-July 06), its involvement in new ink cartridge parts, as well as sub-module assembly for HP’s new 6 individual inks printer mechanism. FE also benefited from HP’s introduction of more models that utilise the 6 individual inks cartridge system. FE expanded its involvement from two models in FY06, to four models in FY07. Like most of the other HP’s inkjet printer parts suppliers, FE’s facilities supporting the Business machine segments are now operating at close to full capacity, tracking closely to HP’s busiest period (between Apr/May to Oct, before tapering off in mid-Nov). In addition, its new printer-related customer (through Flextronics) in Southern China is expected to start mass production in 4Q06.
HDD component business, which accounted for 44% of FY06 sales, will continue to be driven by Seagate’s volume growth and the proliferation of drives used in consumer electronics and 2.5” products. Seagate earlier reported a steady 7% yoy growth in unit shipments for the June quarter, and has guided for a healthy 11-18% yoy growth in the September quarter (assuming 1.2% qoq decline in weighted ASP). The introduction of more high capacities drives for consumer applications will also have a positive impact on FE as these drives typically need air comb, a component that FE only started in FY05. FE is also likely to benefit from the expected rise in volume from Seagate following the completion of the latter’s acquisition of Maxtor in end-May. The combined unit has about 40% global market share now.
In the automotive segment, sales picked up after a sharp yoy dip in FY06. Growth is coming largely from its involvement in new programmes like illumination parts, door lock mechanism, and other molded components. Mass production for some has already started. FE also secured several modular assembly programs (through the help of its JV partner, Dekorsy), with most expected to commence production in 2007. These include bezels for Visteon and ArvinMeritor, as well as instrument cluster for Siemens VDO. The new 50:50 JV with Dekorsy is also on track to commence production in end-06 or early-07.
Margin pressure from higher material costs and weaker US$ as expected. According to FE, margin was affected by the weaker US$ and higher material price in the June quarter. However, margin is expected to improve in the September quarter, on the back of better utilisation, tight cost control, and greater economies of scale. Our previous assumptions already factored in the erosion of margins due to higher material price and weak US$.
Risks Continuous rise in material prices. Persistent high oil prices may result in upward pressure on resin prices. This in turn may put pressure on margin as some of FE’s customers are not on cost-plus model. Greater-than-normal pricing pressure from Seagate in near term. Key HDD customer, Seagate, may take the opportunity to exert greater-than-normal pricing pressure following the merger with Maxtor.
Slower-than-expected ramp for the new automotive programs. The new automotive component programmes are prone to delays or slower-than-expected initial ramps, which are quite common in the automotive business. Valuation and recommendation Forecast tweaked, but Outperform rating maintained.
We raised FY07-09 sales projection but our profit forecasts remain relatively unchanged due to our downward revision of margin assumptions. We deem FE attractive at 5.6x CY06 P/E vs. its historical average forward P/E of 11x. However, we lowered our target price from S$1.37 to S$1.10, using 8x CY06 earnings instead of 10x in view of the P/E compression for plastic injection molding companies and its slower EPS growth in FY07. Maintain Outperform for its steady earnings growth, healthy ROEs, and undemanding valuations vis-à-vis industry peers. --CIMB
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