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Tuesday, April 7, 1998
Komag Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KMAG)") else Response.Write("(Nasdaq: KMAG)") end if %>
Phone: 408-576-2000
Website: http://www.komag.com
Price (4/6/98): $14 1/16
HOW DID IT FIND TROUBLE?
Komag is the King Kong manufacturer of computer disks. But the giant beast
has been mangled in the last year by missteps in the jungle that is the computer
disk drive industry. Cut in half last summer, the stock was sliced up again
following last fall's market massacre.
In the first half of 1996, Komag was operating at full capacity with terrific
yields on its inductive media products and with gross margins over 40%. But
as Komag ramped up media for new magnetoresistive (MR) drives in the latter
half of '96, the company had difficulty getting its production lines up to
speed. Sales fell due to the miscues, leading to higher unit costs and
disappointing gross margins of 24% and 12% in the final two quarters of that
year.
Yet 1997 brought strong demand and improved production yields, pushing gross
margins to the 24% level by the first quarter. Komag's success depended on
strong demand from Seagate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> for media to go into that firm's
enterprise class drives, but Seagate was working to boost it own media
production. By June, the drive maker was also seeing serious competition.
Komag got caught in the crunch. Sales plunged and gross margins contracted.
Seagate and Quantum <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %> accounted for 35% of sales in the
second quarter but just 10% in the third. That's when Komag took a $52 million
restructuring charge to consolidate its U.S. manufacturing operations.
Then came the second wave of industry troubles as Fujitsu and others started
slashing drive prices, pressuring component suppliers as excess inventory
and capacity led to a disk drive crash amidst the October market troubles.
Despite Komag's strong move to newer MR and proximity-inductive products,
selling prices for the year inched up just 1%.
Komag was hurt further because it had increased capacity 25% in 1997, just
as demand was drying up. That helped crush gross margins, which sank from
30.4% in '96 to 14.8% in '97. In January, the firm warned of continued weak
demand in the desktop area. Komag now expects first quarter revenues could
fall even more than expected, perhaps as much as 55% from the fourth quarter's
$159 million, resulting in a significant loss.
BUSINESS DESCRIPTION
Komag is the top independent developer and manufacturer of mostly 3 1/2 inch
magnetic thin-film disks for computer hard drives used in PCs, servers, and
workstations. In 1997, its customers included all of the leading drive
manufacturers: Western Digital (38% of sales), Maxtor (19%), Quantum (15%),
Seagate (14%), and IBM (10%). Seagate accounted for 52% of sales in 1996.
After closing two factories in California in the last year, Komag has
concentrated its manufacturing operations in Malaysia, close to its customers'
facilities. The move was designed to cut costs as well as expand capacity
to over 100 million drives by the end of this year.
Its competitors include HMT Technology plus most of its customers. IBM and
Seagate now produce more than 75% of their media demand internally while
Western Digital provides a third of its own needs with plans to boost production.
Maxtor also has started producing disks internally.
FINANCIAL FACTS
Income Statement
12-month sales: $631 million
12-month income: ($22.1 million)*
12-month EPS: ($0.42)*
Profit Margin: N/A
Market Cap: $742.5 million
(*Includes $52 million restructuring charge)
Balance Sheet
Cash: $166.2 million
Current Assets: $371.7 million
Current Liabilities: $75.6 million
Long-term Debt: $245 million*
(*Also $73 million in deferred taxes.)
Ratios
Price-to-earnings: N/A
Price-to-sales: 1.2
HOW COULD YOU HAVE SEEN IT COMING?
Given Komag's enormous dependence on Seagate, the first sign of troubles
at that drive maker late last spring were cause for concern. When a company
has a concentrated group of customers, an investor should pay very close
attention to how those firms are doing. Seagate's troubles in the enterprise
segment drove
Komag into the pavement.
Western Digital's early November
warning
meant the troubles with overcapacity and excess inventories that Komag had
been dealing with were sweeping the industry. That was very bad news given
that most of Komag's customers also made some of their own disks.
WHERE TO FROM HERE?
At the end of December, the backlog stood at $24 million versus $113 million
a year ago. That says a lot. According to Komag's March 25 press release,
CEO Stephen Johnson now expects second-quarter sales to "rebound sharply
from the severely depressed" levels expected for the first quarter. Even
so, excessive supplies will keep pricing very competitive, meaning Komag
expects a loss for the second quarter, too.
The latest First Call earnings estimates indicate a loss of $1.04 per share
for FY98 with one analyst expecting a $1.00 per share profit in FY99. To
measure the degree of Komag's fall, not long ago analysts were expecting
FY99 profits of $3.50 a share.
The silver lining is that Komag will be granted a ten-year tax holiday on
its second and third plants in Malaysia. So the tax benefits the company
has enjoyed will be enhanced.
Yet Komag must also improve its manufacturing if the firm hopes to remain
competitive. A recent Deutsche Morgan Grenfell report indicated that HMT's
December quarter cost per platter was just $6.69 versus $10.34 for Komag.
The Malaysian focus should help on labor costs, but increasing production
yields is crucial.
International Data Corp. sees 17% compound annual growth for the drive industry
through 2001, below the 23% rate of 1997 but still healthy. Yet the leading
drive makers have increased their disk output and now hold market share in
the mid-to-high 40% range, up from the low 40% range for much of '97.
HMT is also coming on strong. Komag's March quarter '97 sales were 2.6 times
HMT's revenues. For March of '98, they'll be neck and neck. Some analysts
expect HMT to boost its market share from 7.4% last year to 9.4% this year.
The total disconnect between Komag and HMT during the past year suggests
that with the growing captive capacity of the drive makers, Komag must get
better or risk being even more seriously squeezed.
The only good news is that the market seems to have discounted the bad news.
The stock hardly budged on word in late March that the first quarter would
be a little worse than expected.
-- Louis Corrigan
([email protected])
Check out the Daily Trouble Message Board!
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