Armstrong Industrial (KimEng)

Event

As the global supply chain gets back on its feet following the March 2011 Japanese earthquake, Armstrong should get a reprieve in 2H11. But given the continued weakness in China auto sales and the US$, the recovery is not expected to erase 1H11’s 57% profit decline and YoY growth could remain in the negative territory. However, we believe the stock has factored in the poor operating environment. At 7x FY12F earnings and almost 8% yield (based on $0.02 final DPS), we upgrade Armstrong to HOLD with a target price of $0.29 (8x FY12F).

Our View

The global manufacturing supply chain has stabilised in the aftermath of the earthquake/ tsunami that hit Japan in March this year. Recently, major Japanese automakers such as Honda and Toyota predicted a strong rebound in 2H11. On the HDD front, demand is not as robust given weak PC sales but Armstrong is taking market share from competitors. Also, it has recently gained new customers in the China auto sector.

Overall, however, China auto sales continued to underperform last year as a result of the retraction of government subsidies and the introduction of vehicle quotas in major cities like Beijing. Still, Armstrong believes it will benefit from the expansion plans of its major customer Volkswagen, which is building new plants or expanding capacity in southern and western China.

With this mixed demand picture, we expect Armstrong’s 2H11 profits to improve over 1H11, which was hit by the weak US$ as well as the Japanese quake. However, YoY growth is still likely to be negative. Key challenges still include higher operating costs including raw materials and selling costs, as well as continued weakness in the US$ which dented 2Q11 revenue by 5%.

Action & Recommendation

We upgrade our recommendation to HOLD with a target price of $0.29 as we roll over to FY12 earnings, still at 8x PER. We believe the poor operating environment has already been factored into the share price.