HTCH - Hutchinson Technology

[PlanMaestro]

Hutchinson is one of only three manufacturers of suspension assemblies for hard disk drives (HDD), the other two are Japanese, that has been struggling with the transition to a new production technology TSA+ and a new production plant in Thailand. Its Market Cap is $65 million ($2.75 per share).

 

For a description of the business and the historic issues that brought us this price I have uploaded a research report by High Road Value. I hope he does not mind, if he does I will take it down.

 

http://www.scribd.com/doc/59083141/HTCH-Hutchinson-Technologies

 

I have been following the situation for the last two years without investing. It is one of those turnarounds where the new technology/plant ramp-up takes longer than the expected worse case and problems seem never ending

 

However, today the company announced that it is at a run-rate of 130M assemblies per Q, a 30% increase over the last Q, and that they are once again gaining market share. The importance is that with their vertically integrated plant they are the lowest cost producer.

 

http://www.sec.gov/Archives/edgar/data/772897/000119312511182348/dex991.htm

 

"The company shipped approximately 118 million suspension assemblies in the fiscal 2011 third quarter, up 15 percent compared with its second quarter shipments of 102.3 million. Net sales for the quarter totaled approximately $72 million, up 14 percent compared with its second quarter net sales of $63.3 million. "

 

“Our shipments over the last nine weeks of our third quarter averaged approximately 10 million suspensions per week, and we expect this pace to continue into the fourth quarter.”

 

 

With this pre-announcement  they should be close to FCF breakeven and with that run rate, revenue should be above $79M  in Q4.

 

The earnings breakeven is $70-75M per Q today. It went down from above $100M two years ago and they expect to reduce it further ($15M per Q in expense reductions). There should not be more investments going forward and they have $6 to $7M per Q of higher depreciation over maintenance capex.

 

Estimate Q2 2011

Suspension assemblies per Q = 118 million

Average Price = $0.61 per assembly

Revenue = $72 million

Breakeven = $70 to $75 million

Taxes = 0

Net Income = ($5) to 0 million

Depreciation - Capex = $6 to $7 million

Free Cash Flow = $3 to $9 million

 

With the current rate and without including expense reductions:

 

Estimate Q3 2011

Suspension assemblies per Q = 130 million

Average Price = $0.61 per assembly

Revenue = $79 million

Breakeven = $70 to $75 million

Taxes = 0

Net Income = $4 to $9 million

Depreciation - Capex = $6 to $7 million

Free Cash Flow = $10 to $16 million per quarter

 

This is a company that had sales of $716 million in 2007 (aprox 210 million assemblies per Q) and 40% market share (now close to 20%) before the  transition. Also, HDD is expected to continue growing at a 8-10% rate over the next years despite solid state drives SSD recent successes.

 

The major risk is that they have $120M in convertible bonds putable in Feb 2013, and only $50M in cash. They are tendering for the converts with a new series that would extend them to 2015 in exchange for a higher seniority, higher interest rate, and lower convertible price. Also there is always the risk of production disruptions that with the high fixed costs could put them deeply on the red.

 

Long term, the consolidation in only 3 clients can also result in pricing pressure. Also HDD is a business with some cyclicality. (30% unit drop from Q2 2008 to Q2 2009 that quickly recovered to trend)

 

I am not a major expert in the industry and would love some comments especially potential risks.

[mankap]

Nice summary

Did HTCH say that price/unit will be 0.61 or is that your assumption.

This is the concern I have is that price/unit may drop further in 3Q

[PlanMaestro]

Nice summary

Did HTCH say that price/unit will be 0.61 or is that your assumption.

This is the concern I have is that price/unit may drop further in 3Q

 

The revenue and unit production comes from the release. The price is of course those two divided, and has been stable the last few Qs.

 

Price overall has been under pressure the last 3 years (it was $0.8+ in 2007) because of excess capacity. The future is not so clear, there is a new product technology (that would use the same production technology) where HTCH dominates that would be positive in terms of prices and margins. At the same time there is a lot of excess capacity. HTCH has a 16-18 million per week capacity and its current run-rate is "only" 10 million. At least the run-rate is 30% better than a quarter ago :)

 

Regarding those FCF numbers, I think I jumped too early to conclusions. Their $70-75 million per Q breakeven is probably still 2-3 quarters away so they will probably still be a little FCF negative this Q. The good news is that they are guiding even further cuts after that.

[PlanMaestro]

From today's news

 

http://www.startribune.com/business/125115144.html

 

Analysts agreed that Hutchinson results are impressive, and are based on a resurgence in demand for personal computer hard-disk drives, many of which use Hutchinson Technology components. In addition to normal demand, the disk drive industry is trying to make up for a manufacturing slowdown that occurred when Japan’s earthquake and tsunami created a shortage of electronic parts, they said.

 

One of the chief beneficiaries of those trends has been disk drive maker Western Digital, which is a major user of Hutchinson‘s “suspension assemblies,” which suspend reading and writing chips above rapidly spinning magnetic disks.

 

———————–

 

“I think Hutchinson can sustain this recovery, because their cost cuts have been dramatic,” said Mark Miller, an analyst at Noble Financial Capital Markets in Boca Raton, Fla. “The cost cuts combined with improved overseas efficiencies have brought their break-even point down to $75 million or less — and they’re already at $72 million in the third quarter.”

 

But others warn that Hutchinson’s recovery could be short-lived.

 

Jayson Noland, an analyst who follows Western Digital for Robert W. Baird in Milwaukee, said Hutchinson could prosper if other disk drive makers sign up for more of its parts. But Hutchinson’s gains could be temporary if it continues to rely heavily on Western Digital, which is expected to lose market share to Toshiba. Earlier this year, Western Digital accounted for 58 percent of Hutchinson’s revenue.

 

The next critical hurdle in Hutchinson’s recovery will be whether bondholders agree to renegotiate its $122 million in convertible debt that is due in January 2013, Miller said. The company is seeking to extend the deadline two years.

 

———————–

 

http://blogs.forbes.com/ericsavitz/2011/07/07/seagate-western-digital-gain-as-j-p-morgan-turns-bullish-on-drives/?partner=yahootix

 

The analyst writes this morning that both companies “stand to benefit from favorable pricing conditions and bottoming unit trend-lines. The combination of these factors stands to drive upward pressures to consensus numbers beyond the near term.”

 

Moskowitz says the key to the drive sector is to watch pricing trends. “Our long-held thesis in evaluating the investment profile of the HDD segment has been that pricing, not units, matters most,” he explains. “Given that we think units could be bottoming, coupled with a favorable pricing environment, the HDD sector could be setting up for a major gross and operating margin expansion wave. Pricing has been flat to upward-biased in many parts of HDDs, and there have been no indications of over-supply.”

[twacowfca]

Here's my 2 cents.  They are in a commodity business, and the economics is such that they will be lucky to make their cost of capital, long term.  Their leverage accentuates the risk.  Also, there is always pocket risk with small tech companies.  There may be greater pocket risk with offshore companies or offshore ownership (in relation to N. America ) than onshore.  Who controls the company is very important.

 

Having said this, it is possible to make a lot of money from  a quick turn in a commodity business, especially if a company makes a turnaround at the same time pricing firms up.  This actually happened to me on a pure speculation several years ago.  The price ran up so fast and so high that I was nonplussed about what to do: take the money and run and face a short term gain or wait for a long term gain.

[PlanMaestro]

I am not fan on Einhorn but he is still a very good investor. And it looks like we think alike on the economics of the industry... from today

 

Seagate Technology (STX) is a manufacturer of hard disk drives. Hard disk drives are used in desktop and notebook PCs, external storage devices, enterprise storage, digital video recorders, and other consumer applications. The market is concerned that prospective hard drive unit demand will be weak due to macro weakness, substitution to flash (solid-state) storage, cannibalization of PC sales by tablets, and greater storage efficiency in the cloud. Though we don’t expect unit demand to fall anytime soon, the hard drive companies have flexibility in their business models and should be able to adjust their operations to protect profitability should unit demand decrease. Hard disk drive technology represents the cheapest, highest capacity storage solution in a world where data needs continue to grow exponentially. STX is currently in the process of acquiring Samsung’s hard drive operations. Western Digital, its leading competitor, is currently in the process of acquiring Hitachi’s hard drive operations. Following these transactions the industry will have 3 rather than 5 major players, which should increase operating stability. STX management has a large equity interest in the company and appears to be focused on shareholder return. STX repurchased $710 million of stock (~10% of shares outstanding) in the last 2 quarters and has $1.6 billion of capacity remaining under the current repurchase authorization. In April, the company also initiated an $0.18 per share quarterly dividend, providing a 4.5% yield. The Partnerships established their position at $16.06 per share. We estimate that STX has at least $3 per share of earnings power. STX shares ended the quarter at $16.16 each

[cofabmd]

Average forward analyst earnings estimates for STX is 1.90. Einhorn thinks they can do $3. If Einhorn is correct it may imply HDD demand is not yet priced in for HDD manufacturers and it’s suppliers.

 

http://blog.covestor.com/2011/03/hutchinson-technology-is-a-survivor-tenstocks-htch-wdc

 

[PlanMaestro]

They are in a commodity business, and the economics is such that they will be lucky to make their cost of capital, long term.  

 

Absolutely, they invested more than $300M (not including operating loses) in the new plant and they have other investments in the US. I think if they survive that should be an expectation of value.

 

Now, that there only three clients and three competitors, I would expect more rational behavior ... but that is to be seen.

 

Their leverage accentuates the risk.  

 

They have retired close to 50% of their debt, and they have remaining only around $150M that is basically equal to their working capital. The issues come if they do not manage to ramp/up and they keep sustaining cash flow losses.

 

Also, there is always pocket risk with small tech companies.  There may be greater pocket risk with offshore companies or offshore ownership (in relation to N. America ) than onshore.  Who controls the company is very important.

 

Good points. In terms of technology step ups the roadmaps do not not show any changes for suspension assemblies. SSD might be an issue but it looks overblown.

 

To have manufacturing very concentrated in Thailand is an issue. There might be supply disruptions political or of other types (tsunami in Japan)

 

Having said this, it is possible to make a lot of money from  a quick turn in a commodity business, especially if a company makes a turnaround at the same time pricing firms up.  This actually happened to me on a pure speculation several years ago.  The price ran up so fast and so high that I was nonplussed about what to do: take the money and run and face a short term gain or wait for a long term gain.

 

That is the bet, and they have 6-8 million of excess capacity of suspension assemblies (SA) per week, so there is plenty of room for improvement.

 

[PlanMaestro]

I forgot to mention that they are also negotiating a $35 million credit facility

 

http://www.marketwatch.com/story/disk-drive-makers-rise-on-hutchinsons-forecast-2011-06-14?reflink=MW_news_stmp

[PlanMaestro]

Here are comments on the drive space made Friday by Morgan Stanley, I am wondering why Einhorn bought Seagate instead of Western Digital. It looks similarly priced and has been outperforming Seagate for several years.

Low Hard Disk Drive Inventory Sets Up for Strong C3Q US HDD inventory drawdown sets up for strong C3Q in our view:

 

Our US HDD Channel tracker highlights a 28% decrease in inventory units over the past three weeks and a return to sub 4-weeks of channel inventory vs. normal of 4-5 weeks (Exhibit 12). Our recent trip to Asia also leads us to believe China distribution inventory is just 10 days versus the normal 4-5 week range. Low channel inventory levels set up for better than expected September quarter unit guidance, in our view.

 

We published a positive Research Tactical Idea (RTI) on Western Digital on 6/22/11 after supplier meetings pointed to potentially better shipments in the June and September quarters. ASP declines less than normal, as expected: Like-for-like ASPs in the US distribution channel fell just 1% in C2Q compared to a similar decline in C1Q and normal declines of 3-5% quarterly. This is in-line with our forecast of a 1.1% ASP decline for the HDD industry in the June quarter. Low inventory levels entering C3Q could set up for a continued favorable pricing environment.

 

HDD supplier guided to better September shipments, share shift:

 

Hutchinson Technology reported a better than seasonal 15% Q/Q shipment increase in June and an expectation for another unit increase in the September quarter. We believe Hutchinson is benefiting from share gains at WDC and STX. For perspective, we currently model a 6% Q/Q unit increase in the September quarter below normal of 15% and just above last year's trough of +4% Q/Q. Hutchinson's commentary and low inventory levels imply that our forecast could prove conservative.

[PlanMaestro]

Thinking the unthinkable, strange things happen in this world.

 

http://seekingalpha.com/news-article/1995133-hutchinson-technology-announces-its-operations-in-thailand-have-been-temporarily-suspended?ifp=0&source=email_porfolio

[king888]

Thinking the unthinkable, strange things happen in this world.

 

http://seekingalpha.com/news-article/1995133-hutchinson-technology-announces-its-operations-in-thailand-have-been-temporarily-suspended?ifp=0&source=email_porfolio

The flood situation are really bad in Thailand.Last year,we had waterflood in Southern part.Today,it moved from Northern part to Central part of the country already.The weather climate turns very bad every year in Thailand.Next year might be worse.

[PlanMaestro]

13D by a self-styled Graham & Dood investor goes big. I'm on the sidelines still waiting for my one-foot hurdle after the Thailand flooding.

 

http://finance.yahoo.com/news/hutchinson-technologys-2nd-largest-shareholder-141402458.html

[ItsAValueTrap]

A slight negative for the Hutchison companies is that Li Ka Shing (sometimes the world's richest person) may take it over like he did for Hutchison Telecommunications.  If you want to compound money over the long run, this is not so good as you may be forced to sell your See's Candies-type business in a takeover.  Then again, I don't think that this is a good company to own in the long run.  Computers have been in a huge secular bull market yet the performance of this stock has been rather anemic since inception.

 

It's obvious to me on the technology side that traditional hard drives will slowly lose share to solid state/flash.  It's happening now and the trend is obvious.  As flash drives increase in capacity, they will start getting to the point where they have enough storage space at a reasonable price.  A growing number of people will buy a computer with only a flash drive (as they are doing now for ultrabooks and some high-end laptops).  I don't think the traditional hard drive market will ever die off completely but it will see a slow decline.

 

If they didn't make money in a bull market, then what do you think will happen to them in a bear market?

 

2- The rate of improvement in flash will slow down as time goes on as error rates will start to increase and require more error correction.  That's if you look really far out into the future.

[meiroy]

 

ItsAValueTrap,

 

That might be so, what about break-up/assets/patent value? P.S. enterprise/cloud servers still require such products.

[ItsAValueTrap]

I haven't researched the company much at all so you may have an edge over me.  (I have not read any of the 10-Ks or 10-Qs.)

 

On a GAAP profitability basis, the company looks terrible as it continues to lose money.

On a free cash flow basis they look better.  D&A consistently exceeds capex.  Still... a cursory look at the company shows that they don't generate a lot of cash.  Only in the last few quarters have they been free cash flow positive.

http://www.gurufocus.com/financials/htch

 

In an orderly break-up scenario, I have no idea what they will get for their assets.  I would imagine that their assets require a lot of know-how and that the market for buyers are very limited (presumably their few competitors and their customers).  Because the assets don't generate a lot of cash flow they may not sell for much?

I have no idea if they own valuable patents.

 

P.S. enterprise/cloud servers still require such products.

I am guessing that the mix between flash and traditional hard drives will move a little more towards flash.  There are many hybrid approaches out there that take advantage of the best of both worlds.

 

2- The combination of debt, historically poor economics of the industry, and shrinkage of the traditional hard drive market would make me too scared to own this stock.

 

2b- The nasty thing about some technology manufacturing companies is that there are dynamics that make price competition intense.  For flash memory, the underlying driver is this:

Higher capex on a new generation plant --> more economies of scale --> lower operating costs

 

This often leads to overbuilding in the industry and intense price wars as the overbuilders clear inventory / try to recoup their capex.  The flash memory manufacturers are all going to make really good products but they probably won't make a lot of money.  Micron for example has negative retained earnings.

[PlanMaestro]

HTCH continues its huge run-up, that I did not participate in, and it has room to go if the turnaround is successful. There were some great news in the CC: market share, price and density increases.

 

However, they have been very slow in the restart of the Thailand plant after the flooding (only 18% of total production in the quarter) and they are not projecting profits until next year. In my opinion, it's all about Thailand.

 

It's not a great business so waiting for some disillusion/opportunity over the next year might be appropriate. Hey, they are still very cash flow negative and some bond maturities are coming. If not … tough luck.

 

http://www.readability.com/articles/uclcmda1

[PlanMaestro]

http://seekingalpha.com/article/1433371-hutchinson-technology-extraordinarily-undervalued-about-to-become-a-lot-less-so

[berkshiremystery]

http://seekingalpha.com/article/1433371-hutchinson-technology-extraordinarily-undervalued-about-to-become-a-lot-less-so

 

PlanMaestro,...

 

actually Chris Rees (aka TenStocks.com... and The Buffett's Next Door) was one of the earliest investors that took a big position in them some while ago. He runs a very concentrated portfolio also with BofA.

 

http://www.tenstocks.com/

http://covestor.com/chris-rees/tenstocks

http://m100.marketocracy.com/crees_10STX/1performance/index.html

 

[PlanMaestro]

PlanMaestro,...

 

actually Chris Rees (aka TenStocks.com... and The Buffett's Next Door) was one of the earliest investors that took a big position in them some while ago. He runs a very concentrated portfolio also with BofA.

 

http://www.tenstocks.com/

http://covestor.com/chris-rees/tenstocks

http://m100.marketocracy.com/crees_10STX/1performance/index.html

 

Well, it seems like a missed opportunity. Tough luck and tough decisions, the Thailand floods made a mess of things and the TARP warrants were there for the picking too.

[berkshiremystery]

PlanMaestro,...

 

actually Chris Rees (aka TenStocks.com... and The Buffett's Next Door) was one of the earliest investors that took a big position in them some while ago. He runs a very concentrated portfolio also with BofA.

 

http://www.tenstocks.com/

http://covestor.com/chris-rees/tenstocks

http://m100.marketocracy.com/crees_10STX/1performance/index.html

 

Well, it seems like a missed opportunity. Tough luck and tough decisions, the Thailand floods made a mess of things and the TARP warrants were there for the picking too.

 

Not sure, but about three years ago I was looking into Chris portfolio, saw both HTCH & BAC. Chris was watching HTCH very closely and was posting in his articles that they would sooner or later recover from the Thailand floods. BAC was of course his biggest position, HTCH, second place. Only me,... then after BAC was way down after his initial purchases, I rather also choose to move slowly into BAC and making it after their big drop some extremly big position for myself. I guess Chris was only a little too early to spot Berkowitz thesis about BAC, similar to WFC and the old OID write-up in the 1990's. So he got in at almost the same prices like Berkowitz, while we here got in at lower price all the way down around $5 bucks. But since that I'm watching his moves as closely as Lotsofcoke in the old days, some decade ago. 

[jeremykgold]

Does anyone know if they have given any long term guidance or hope for gross margins?