KOMG

[Michael]

Have you ever been punished for a misdeed somebody else did?

Well KOMG has been punished because Hutchinson guided lower citing weak demand: http://biz.yahoo.com/bizj/050830/1157601.html?.v=2

It fell from 37.5 down to the support at 32.5 (13%). It is always important to follow sector news when you consider to buy a stock. Not only can it warn about potential weaknesses or strength in the sector but it can also offer great buying opportunities,

In the case of KOMG I think the drop was unwarranted. I have therefore bough at 32.57.

KOMG designs and manufactures thin-film media or disks that are incorporated into disk drives. On July 27 the company said:

"Overall demand remains very strong entering the traditionally seasonally stronger second half of the year. As we are currently running at full manufacturing capacity of approximately 27 million disks per quarter, we expect revenue to be similar to the prior quarter. Net margin in the third quarter is currently expected to be approximately 16%, without giving effect to any potential impact of exchange rates.

Based on very strong demand that currently exceeds our manufacturing capacity and expected continuing strong overall market growth, we are in the process of expanding our capacity by approximately 4 million disks per quarter. We expect initial incremental capacity from this expansion in the fourth quarter of 2005 and total capacity of approximately 31 million disks per quarter by the end of the first quarter of 2006.

Now that doesn't sound like a company that is experiencing a drop in demand does it?

In fact one of the biggest problems until now in the HDD industry is the supply of thin film disk. Merrill Lunch was not late to inform their customers:

Implications for Komag: Although Komag shares are trading in sympathy with Hutchinson, please note that disk media remains the bottleneck. Also note that Hutchinson missed its June quarter target, whereas Komag positively preannounced in June.

and Piper Jaffray followed up:

Komag (KOMG) is down nearly 4.3% on the news and represents a great buying opportunity at these levels trading at 9-10x forward earnings. Our analysis indicates
that Komag is being unfairly punished on the heels of the Hutchinson pre-announcement. We believe that Komag will easily make the quarter given the strong demand for its products on the back of continuing substrate constraints. Reiterate Outperform and $40 price target (12-14x P/E, 1.4-1.6 P/S). Risks include slowdown in desktop PC HDD demand, oversupply of media capacity or a fall-off in enterprise HDD demand.

And then today Zack upgraded the stock to strong buy:

CHICAGO--(BUSINESS WIRE)--Sept. 1, 2005--Zacks.com releases another list of stocks that are currently members of the coveted Zacks #1 Rank (Strong Buy) List. The #1 Rank stocks highlighted today are Helmerich & Payne, Inc. (NYSE:HP) and Komag, Inc. (NASDAQ:KOMG).

Komag, Inc. (NASDAQ:KOMG) released its report for the second quarter in late July, stating that overall demand for its products from all four of its major drive customers was extremely strong. Second-quarter earnings of 93 cents per share topped the consensus estimate by approximately 13% and outperformed last year's result. The company exceeded the consensus estimate each time during the past five consecutive quarters.

I will write a bit more about the company over the weekend but let me finish we the chart:

[Michael]

Nice opening this morning. We might be helped by Jim Jubak's comments:

Jubak's Journal

By Jim Jubak

I'm going to ignore my own stop loss at $33.60 on shares of Komag (KOMG, news, msgs) and hold on because I can't find any fundamental reason for the decline. It's likely investors will have real news from the company in the next few weeks, and I'm willing to go with these shares until then. Shares took a beating on Aug. 30, falling 12.2%, on news that disk-drive suspension maker Hutchinson Technology (HTCH, news, msgs) had lowered its estimates for that company's fourth fiscal quarter that ends on Sept. 25, 2005. I think the issues raised by Hutchinson Technology are specific to that company and don't indicate any problems in the quarter for Komag. I'd use the weakness to buy shares of Komag. (I'm buying shares on this weakness myself.)

Hutchinson Technology cut its sales estimates for the quarter to 170 million-180 million suspension assemblies from an earlier estimate of 190 million-200 million units. That weakness in demand, plus a shift in revenue mix toward products that carry a lower profit margin, will reduce gross margins to from 19% to 23%, from an earlier estimate of 28% to 30%. I don't see any signs that the weakness in demand for Hutchinson Technologies suspension assemblies carries over to the hard disk-drive media produced by Komag. Channel checks by Wall Street analysts show five to six week inventory, improving sell through, and slightly higher selling prices. Remember that just this happened in the June quarter when Hutchinson Technology missed estimates and Komag positively pre-announced. As of Sept. 2, I keeping my $48 price target by December 2005 on these shares and removing my stop loss. (Full disclosure: I own shares of Komag.)

The Company announced yesterday that they are going to Present at Citigroup's Technology Conference on September 8 and I am pretty sure that they will confirm their earnings forecast on this conference.

[Michael]

KOMG has been on my watch list for a looong time. I was therefore very pleased when I got a buying opportunity last week.

I posted a white paper about Momentum Investing on the "Stock Market Talking" Board over the weekend (http://www.3stocksonfire.org/trading/index.php?topic=2565.0). KOMG was one of the stocks that came to my mind when I read the paper.

It has certainly outperformed 85% of all stocks:



Net Income is rapidly increasing:



The only flaw this share has according to the paper is a PE of only 14 but I can live with this :

Merrill Lynch raised their estimates on Friday. I can't remember last time an analyst raised earnings estimates for a stock that has fallen 20% over the last 5 trading days. That takes a lot of balls having in mind that the drop was initiated by earning worries:

Highlights:

• The share price of Komag has declined by about 20%
( $8 ) from $40 recently, which we attribute to: A)
concerns regarding Hutchinson's negative
preannouncement, and B) anxiety regarding
disappointing mid-quarter updates from the HDD
sector next week. (See our accompanying MXO
note.)

• Reiterate Buy. We believe that Komag's CQ3
remains on track and we consider the shares to be
particularly attractive following near-term weakness.
Shares could exhibit further weakness over the next
few days (due to concerns about next week's updates),
but this should be short-lived.

• 160GB/platter is a negative for SAs, not media.
According to our checks, Seagate started shipping
160GB/platter desktop drives to the distribution
channel last week. These drives shipments are more
negative for suspension assembly companies than for
media companies. For example, an 80GB HDD
usually ships with 2 SAs and 1 disk platter. Using 1
side of a 160GB platter, an 80GB HDD will only need
1 SA (vs. 2 before), but will retain a single disk.

• July HDD production data not too negative
regarding Komag's CQ3. The sum of HDDs
produced by Komag's customers declined by 3% in
July compared to April, according to TSR. A 3% seq.
decline in shipments in CQ3 would only amount to
800K less units, which impacts CQ3 EPS slightly by
$.03 (out of our $.89 estimate). As we believe that
demand for media outstripped supply in CQ2 by at
least 800K units, the results from TSR support the
company making its guidance.

• We are slightly tweaking our FY05/FY06 EPS
estimates from $3.21/3.84 to $3.23/3.86.

July HDD Production Data
July production healthy, but US vendors losing share to
Asian vendors. HDD production data for the month of
July from TSR suggest a fairly healthy overall HDD
environment (up 3% in overall HDD units comparing July
with April) with strength from 2.5" drives but continued
weakness in 1" drives. On the negative side, US-based
vendors (STX, MXO, WDC) appear to be losing market
share to Asian-based vendors possibly due to the mix shift
from desktop HDDs to notebook HDDs. Notebook OEMs
Toshiba and Fujitsu will obviously use their own mobile
drive products before using others.

Maxtor losing share to WDC and Seagate. We note that
both WDC and Seagate showed production growth in July
vs. April in the low to mid-single digits while Maxtor
declined about 19%. The growth exhibited by Maxtor in
July from June is due to an easy comparison as Maxtor's
June production was also quite weak.

Price Objective Basis and Risk
We derive our $42 12-month price objective on shares of
Komag using a DCF analysis. Our 10-year DCF analysis
assumes a long-term revenue growth rate of 5.0% and
gross margin of 26.5% in the terminal year. Applying a
12.7% discount rate the company's current value results in
a 12-month price objective of $42.

Risks to our price objective are:
1.) Increased competition from Showa Denko and
Fuji (to a lesser degree)
2.) A high degree of customer concentration, especially
to Maxtor
3.) Tax credits expiring beginning in C2006,
4.) An inability to ramp well in mobile and SFF HDD
markets
5.) Slower PC growth.

We will most likely get an earnings update at the Citigroup Conference on September 8 so they most be very confident in their estimates!

[Michael]

It seems this is developing into a monologue. Interesting that nobody can see the potential in this stock (or maybe you guys are just to busy buying  ).

As David says the market is always right – that is except when it is wrong (my addition). In the case of KOMG I believe the market was wrong and that the market has realized its mistake and is correcting it.

Still a long way to go though. Following the trend it seems like it will go up to above 40 when/if the earning forecast is confirmed on September 8. That is still 20% over a few days.....

[Michael]

Maxtor had their mid-quarter Conference Call after the close yesterday.

It was a great CC for KOMG! Maxtor emphasized their strong relationship with KOMG and that they might use KOMG to help on media shortage in second half of 2005! They specifically mentioned that KOMG orders would increase in the future when KOMG has expanded the production capacity (KOMG biggest problem right now seems to be that they are running on 100% capacity - still wondering how anybody can be worried about earnings  )

They also said that they experience a strong demand for HDD and that inventories in the supply chain is down to 4 weeks.

This was the last confirmation I needed. I will add to my position this morning.

As mentioned elsewhere I have sold all oil stocks and is rotating back into High-tech like KOMG and CKCM (added today) and Biotech (SVA is on fire!).

Mike

[422fwhp]

What do you make of all the insider selling in August?

http://www.insidercow.com/

[Michael]

Hi Fwhp

I always check insider activity before I buy a stock and I certainly did that with KOMG.

You are right that insiders have sold in August. In fact they have sold shares every month for the last 13 months and it doesn't bother me at all!

The insider activity has been exactly the same since the stock was at 12; it has since increased 300%. The point is that insider activity in case of KOMG gives no indication about the future development of the company.

There can be a lot of good reasons why insiders sell shares: diversification, to support their lifestyle or it can even be a recommendation from the company.

So the jury is out and the insiders are innocent 

[422fwhp]

Thx for your response.  I know insider selling is not as important as insider buying b/c there are many reasons (like you said) for one to sell.

Good luck...on my watch.


laterz...Jody

[ehos]

Nice pick!

Did you buy on the gap up?

[Michael]

Thanks Ehos

No - I didn't buy at the opening (my limit was too low). I have now increased the limit so we will se. As this stock is moving I might just have to buy without any limit.

[LuckyFish]

Thank you Mike.
Nice call on this.  I got in just below 34.  I don't know how long I'll hold on to it, but it's been great so far!
Brigitte

[ehos]

Up on the day, but down after hours.

A nice chance to buy in low?

[Michael]

Hi Ehos and Brigitte,

First of all congrats to Brigitte with the buy. I really think 34 is an excellent entry price.

Ehos I think it will fall back a bit during the trading today. That is at least what I hope. I didn't manage to buy yesterday. This was not due to lack of efforts; I increased my limit three times.

I mentioned the Maxtor CC yesterday and here is the Analyst response:

Piper Jaffray

Media Shortage Continues To Benefit Komag: Maxtor's internal media
production issues continue to suggest continued aluminum media constraints for the
foreseeable future which continues to be a positive for Komag. Given that Komag
is operating at full capacity, we note that Komag probably will not see upside from
Maxtor orders this quarter but we do note that such problems will continue to keep
Maxtor dependant on Komag for a longer time than expected. Maxtor plans to keep
its share of media sourced from Komag at the ~50-60% of internal capacity range
for the foreseeable future.

Bear Sterns

Key Points
Owing to a MXO-specific manufacturing glitch, it lowered its 3Q05 guidance. While the industry dynamics remain healthy (ironically, MXO issues could be positive for the industry), we're maintaining our Peer Perform rating owing to valuation; we prefer to own KOMG, which is better positioned to benefit from seasonal strength given media shortages.

Thomas Weisel

• Komag benefiting from tight platter supply. We believe Komag remains at an attractive valuation of 10.2x our CY06E EPS. The company is benefiting from tight platter supply, as indicated by Maxtor's announcement tonight of a shortfall in its own internal platter capacity leading to missed revenue. Maxtor's problems seem to be in higher capacity aluminum drives, an area dominated by Komag. We remain comfortable that Komag will meet or exceed our estimates for the remainder of the year despite limited potential for unit upside because of capacity limits.

• Maintain Outperform ratings on WD, Komag and Seagate. We beliveve Seagate, WD and Komag trade at attractive valuations of 11x, 10x and 8x our respective CY06 EPS estimates and are best positioned in the near term in terms of product positioning and ability to execute.

and then after close came the long awaited message from Komag:

Komag reiterates revenue, margin forecast
Wed Sep 7, 2005 06:01 PM ET

SAN FRANCISCO, Sept 7 (Reuters) - Komag Inc. (KOMG.O: Quote, Profile, Research) , a maker of media used in computer disk drives, on Wednesday reiterated its third-quarter revenue and profit margin forecasts, saying market demand remained strong in the second half.

In a filing with the U.S. Securities and Exchange Commission, the company also said it is currently running at full manufacturing capacity of about 27 million disks per quarter.

Calling for revenue to be about flat with the second quarter and net margins of about 16 percent, Komag repeated a forecast it gave in July.

Komag shares rose $2.00, or 5.8 percent, to $36.45 on Nasdaq in regular trading. In after-hours trading, the shares gave up 95 cents to $35.50.

The share should shoot up from here but as said I hope we will see a little profit taking till the Analysts reiterates their strong buy recommendations and the market takes it back to the forties.

[Michael]

OK so here are the analyst recommendations:

Piper Jaffray

KEY POINTS:
• Reaffirms Previously Provided 3Q05 Guidance; Upside To 3Q05 Guidance
Possible: Prior to speaking at an investor conference today, Komag put out a
press release yesterday re-affirming guidance for 3Q05 which was exactly the
same as the guidance provided during its 2Q05 earnings call. The Company
expects 3Q05 to be "similar to prior quarter with net margins in the 16% range."

As we have noted, we believe 3Q05 guidance is conservative for the following
reasons: 1) the Company is entering 3Q05 with 27M of capacity - it entered 2Q05
with approximately 22M of capacity which was expanded to 27M during the
course of the quarter; 2) the Company has approximately $8.8M of finished
goods inventory, which could translate to approximately 1.5-2M finished disks
(assuming 25% gross margins, ASPs of $5.55). However, this number could be
lower given that we do not know the exact mix of substrates versus finished disks
in finished goods inventory. But we note that the Company probably has the
ability to ship at least 1M disks from inventories alone; and 3) the Company is
currently assuming zero capacity expansion during the course of 3Q05 - we find
this to be a very conservative assumption.

• Running At Full Capacity; Capacity Expansion Underway: The Company
shipped 27.6M units during the quarter and is currently running at full capacity.
The Company plans to increase capacity by approximately 4M disks per quarter
through the end of 2006. Incremental capacity from this expansion is expected in
4Q05 with capacity of approximately 31M by end of 1Q06 and 40M by end of
2006.

• Reiterate Outperform And $40 Price Target: We believe that Komag will
easily make the quarter (and potentially beat it given its inventory position) given
the strong demand for its products on the back of continuing substrate constraints.
Reiterate Outperform and $40 price target (12-14x P/E, 1.4-1.6 P/S). We would
be buyers on weakness.

Bear Sterns

Key Points

While not as ebullient as 2Q05 pattern when the company raised estimates twice intra-quarter and beat that guidance), KOMG reiterated its revenue/EPS guidance in its mid-quarter update. We are maintaining our estimates and our price target of $49 and see KOMG as the best way to play unit demand in the hard disk drive sector given strong unit demand and industry-wide shortages of magnetic media.

KOMG is a play on the strong secular growth in drive unit demand, though the story is contingent on its successful ramp of finished disk capacity (to 31mm by 1Q06 and 40mm exiting '06) which is largely accounted for by customers. Absent an industry downturn, increased supply or order cancellations, if KOMG can fill its planned capacity additions, we see potential for significant upside from here.

Identical to its comments in July, KOMG said it is running at full manufacturing capacity of around 27mm disks per quarter, implying revenues flat with 2Q -- and net margin around 16%. We are maintaining our estimates for 3Q05 of $0.90 vs. $0.32 last year on sales of $177mm (vs. $173mm in 2Q) -- we see upside from mix, for 2005 at $3.30 on revenues of $675mm and 2006 at $3.75 on sales of $807mm.

In contrast to tone of weak demand from HTCH, which makes suspension assemblies for drives, KOMG noted that it expected overall market demand to remain strong for the industry -- consistent with channel comments we have gathered -- but capacity does not come on-line until 4Q05. While we are mixed in our view of drive vendors given limited upside, we like the capacity expansion story here.

While risks remain around a slowdown in hard drive demand, execution on adding capacity, and KOMG's customers adding internal media capacity, secular demand dynamics are improving and supply conditions remain tight. Applying a 13x P/E multiple to reflect stronger growth and better execution – on our '06 EPS of $3.75 yields our target of $49.

Compelling Valuation: Given the continued favorable supply/demand dynamics in disk media, we are maintaining our price target for Komag at $49 by applying a 13x P/E multiple, which is still a discount to the S&P market multiple. We believe that a 13x multiple is reasonable given the secular demand dynamics for KOMG continue to improve and near-term media supply conditions remain tight.

Well looks good to me and it seems like I can get my shares cheap today 

[Michael]

Bought @ 34.60