Hard Disk Drive: Challenging times ahead (Underweight) (DMG)

The HDD subcontractors have been hit in recent months by a confluence of negative factors, including slowing consumer demand, foreign exchange swings and most recently, the massive floods up in Thailand, where many of them have manufacturing facilities. We believe the share price will continue to be depressed, and see little reason to bargain hunt. We are UNDERWEIGHT the HDD sector, following the downgrades of both Armstrong and Broadway to SELL. Adampak is our sole BUY in the HDD sector.

Muted PC and HDD outlook. Growth for both PC and hard disk drive (HDD) unit shipments are expected to slow to 3.8% and 2.9% respectively for 2011 amid deteriorating consumer sentiment. Though some growth will be eked out this year on the back of mobile HDDs, longterm outlook remains challenging due to tablet and solid-state drive (SSD) cannibalisation. We prefer Adampak as its labelling and die-cutting business can be easily modified to cater for different markets.

Forex swings to weigh on 3Q results. The sharp appreciation of USD against the SGD (+8.5%) since late Sep is expected to significantly impact on the 3Q results of Armstrong and Broadway as the mark-to-market losses of balance sheet items and derivative contracts outweigh the operational gains. Since most of Adampak’s revenue and costs are denominated in USD, it will not feel much impact.

Thai floods to add to the woes. Thailand’s worst flood in half a century has caused major supply-chain disruptions and production suspensions to the HDD industry. Singapore component suppliers are not spared as the likes of Armstrong, Adampak, Broadway and Innovalues all reported that their plants in Ayutthaya will be shut down indefinitely. We are expecting Armstrong to be the hardest hit.

UNDERWEIGHT on the sector but with a BUY rating for Adampak. We retain our cautious view on Singapore HDD players with an exception for Adampak. We favour the stock due to its 1) conservative management style, 2) minimal forex exposure and 3) product interchangeable for horizontal market expansion.