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Stockwatch- Adampak (Singapore), Westcomb research update

Westcomb Research Update on Adampak, 23 Oct 2006

Adampak Limited
Upside potential remains

Essential part of Seagate’s Supply Chain
Adampak plays an important role in Seagate’s supply chain, by providing labels, seals and other die-cut components to Seagate. Seagate was their biggest customer in FY03, taking up 31.9% of revenue. The breakdown of revenue in the subsequent financial years were not disclosed due to non-disclosure requirements but we believe that Seagate remains by far Adampak’s biggest customer.

Adampak has become one of Seagate’s main suppliers because of its ability to achieve flexibility in production and yet maintain quality. For example, Seagate could suddenly ramp-up production because of better-than-expected end-market demand and component suppliers (such as Adampak) would have to be able to meet Seagate’s production requirements.
Seagate is very active in this region and has recently announced that it will invest 1.3 billion Singapore dollars to build a third recording-disk plant in Singapore. The plant will produce recording media disks, which are key components of hard disk drives.

Key supplier for computer-related products and other consumer electronics products
Other main customers in FY03 include HP (20.0%), Western Digital (7.6%) and Maxtor (8.7%). Maxtor has been acquired by Seagate and correspondingly Adampak has seen increased orders from Seagate. HP and Western Digital remain Adampak’s major customers. Fujitsu is also one of Adampak’s customer.

Below is an excerpt from the Nikkei Electronics Asia (August 2006 issue) describing changes in the competitive positioning of component/materials vendors (such as Adampak) in the electronics industry:

In the past, equipment manufacturers could select the components and materials they wanted from a wide range of suppliers, but the slump in the electronics industry from the mid-1990’s to around 2005 saw prices plunge for components and materials. The number of suppliers in the business dropped rapidly, resulting in rising demand for the survivors, and creating chronic component/materials shortages for a variety of equipment. This trend was further accelerated by the need for improved functionality and performance in equipment, resulting in higher technical and capital barriers to developing new components and materials. Natural selection continued in the component/materials industry, leaving a few firms in monopolistic command for the markets."

In many ways similar to Unisteel
Adampak is in many ways similar to Unisteel. Both are making seemingly trivial components for HDD manufacturers. However, both Companies play an important role in the supply chain of HDD manufacturers such as Seagate. In much the same way that HDD manufacturers cannot do without screws, Adampak’s products such as labels, seals and die-cut components are also essential components for HDDs.


Company
Product
Market Share
Market Cap (S$m)
Hist. PER (x)
Forw. PER (x)
Rev.
(S$m)
Net Profit (S$m)
Unisteel
Screws
Approx 50% of the HDD market*
653.3
14.8
13.7
184.3
41.1
Adampak
Labels, seals and die-cut components
Approx 20-30% of the HDD market*
42.2
7.1
4.9
43.9
5.9

Fast-growing HDD industry
In-stat recently reported that the HDD will be a key component in more and more consumer electronics products through the rest of the decade, and expects HDD worldwide shipments to almost double from 380 million in 2005 to 748 million in 2010. Below is an excerpt of the research:

"While hard drives have become small enough to embed in most portable CE devices, competitive storage solutions, such as increasing flash capacities, continue to threaten this market. However, at multi-gigabyte capacities, flash becomes cost-prohibitive. HDDs will more effectively address portable multimedia devices that offer a wide range of capabilities requiring higher storage capacities."

Other than mobile devices, growth in HDDs would also likely come from digital video recorders which are set to replace conventional tape-based video recorders. Imagine the demand for HDDs if all households eventually replace their conventional tape-based video recorders with digital video recorders. This is likely to happen as more and more media Companies are shifting towards digital high-definition technology. HDDs are also increasingly used in automotive applications.

Well-certified in other industries
For FY05, the HDD sector contributed 55.8% of the revenue. The rest of the revenue came mainly from the electronics industry (e.g. computer and peripherals, consumer electronics, etc). Adampak also supplies to Companies dealing with pharmaceuticals/medical equipment, industrial products, and consumer products.

Other than obtaining the usual ISO Certifications, Adampak has also obtained numerous safety agencies approvals from UL (Underwriters Laboratories) and CSA (Canadian Standards Association). UL is a trusted source across the globe for product compliance in public safety.

Long-standing relationship with Suppliers
Adampak’s key supplier is 3M contributing approximately half of the Group’s label stocks. Other key suppliers include Fasson, Raflatac and Lintec.

We believe that Adampak has nurtured good relationships with their key suppliers. Despite the recent surge in oil prices which should have affected the cost of resin-based label stocks, Adampak has still managed to contain the cost of raw materials and even improve margins. According to Management, this is because of their long-standing relationship with suppliers such as 3M.

Proven track record and quality
Adampak’s extensive customer base of MNCs including HP, Seagate, Western Digital, Maxtor, Motorola, Baxter Healthcare, etc, demonstrates their established track record and quality of their product and services; MNCs being known for their stringent quality criterion. Adampak has been awarded "Ship-to-Stock" or similar status by many of their customers, including Western Digital, Seagate, etc. This means that Adampak’s labels can be used directly in customers’ production operations without having to undergo further quality assurance inspections. Furthermore, Adampak has been awarded the "Supplier Appreciation Award" by Hewlett-Packard (S) Pte Ltd and the "Autonomous Quality Control Approval" by Sony International (Singapore) Ltd.

Adampak provides services to pharmaceutical companies such as Baxter Healthcare and Stiefel Laboratories and this is testament of their product quality and hygiene standards.
Major customers, Seagate, Maxtor and Western Digital have been using Adampak’s services for over 10 years.

Good geographical network of manufacturing facilities
Adampak has manufacturing operations in Singapore, Philippines, Thailand and PRC. Through its associated companies, Adampak also has manufacturing presence in Malaysia and PRC. Adampak’s wide network of manufacturing facilities enables them to be in close proximity to their customers, thereby enabling them to provide their services to customers in a timely and cost-effective manner.

Integrated services provider
Adampak is an integrated label converter, with capacity in pre-press and production aspects of the label conversion process. They provide one-stop services from design to production of labels. With such integration, Adampak can better manage the quality of the final products, as well as be more responsive when customers require any rectification to the design.

Wild cards that can provide positive surprises
There are a few wildcards that can provide positive surprises:

(1) Growth in the usage of RFID for baggage handling at airports and logistics and inventory management in the general supply chain. As technology improves and the price of RFID chipsets declines, there will be wider usage of RFID technology in the tracking of items. These RFID chipsets require converters such as Adampak to insert them into labels, which requires sophisticated expertise. Adampak should benefit as the usage of RFID becomes more widespread.

(2) The Group’s new production facilities in Suzhou give them access to the vast PRC electronics market that is growing very rapidly. The Suzhou plant commenced operations in July 2006. Even though at this point we do not expect the Suzhou Plant to contribute positively in FY06, production may ramp-up unexpectedly and make some contribution.

(3) Adampak has a strong balance sheet with net cash of US$4.3 million (or
S$6.8 million equivalent) as of 30 June 2006. Adampak has signalled their intent to purchase the additional 50%-stake in its associate, Aident, for RM20.9 million (approximately S$9.1 million). The consideration represents 6.4x PER (based on earnings for the 12 months ended 31 December 2005). This is still awaiting regulatory approval and we are not certain whether it will go through – hence we have taken out the impact of the purchase from our forecasts. If the acquisition takes place, it will likely be EPS accretive as the purchase consideration will be funded by internal resources and bank borrowings. Even if this acquisition does not take place, Adampak has the financial muscle to purchase other label converters that provide a strategic fit, as well as boost the EPS of the Group, if the opportunity arises.

Attractive dividend yield
1H05
FY05
1H06
Gross Dividend (cents)
0.625
0.9375
0.625
Net Dividend less 20% tax (cents)
0.5
0.75
0.5
Yield (after tax)
2.1%
3.1%
2.1%

Competition
Adampak operates in a competitive environment where there are many small players. However, most of these small players are unable to meet the more stringent requirements of customers such as Seagate. Larger players (with more sophisticated expertise) include Adampak, Singapore-based Zephyr Co and USA-based Brady Corp. Zephyr is a private limited company of larger scale than Adampak. Brady Corp is listed on NYSE with sales of US$1018m in FY06 (July year-end). In 2004, Brady acquired ID Technologies, also a Singapore Company of similar scale to Adampak. Terms of the transaction were not disclosed.

Risks

Over-dependence on electronics sector
Any slowdown in the electronics sector, in particular, the HDD sector, would result in a decrease in demand for Adampak’s products from these customers and would likely affect their financial performance.

Loss of major customers
Any loss of major customers such as Seagate, HP and Western Digital would significantly affect the financial performance of the Group.

Increase in prices of raw materials
Label stocks account for more than 60% of the cost of production. Any increase in cost of label stocks may impact margins.

Currency fluctuations
About three quarters of revenue is denominated in US$ while about half of costs is denominated in US$. Any decline in US$ against S$ will result in decline in profits due to transaction costs. There will also be related translation costs.

Forecasts and valuation
We increase our target price from S$0.33 to S$0.39 based on 8x FY06 PER. Previously, we imposed a 15% discount due to its poor trading liquidity. We have removed this discount due to its recent surge in volume. Maintain BUY.

posted by gsg @ 7:13 PM