• NanoFilm provides renowned blue chip customers with surface vacuum coating technology solutions, which is critical in enhancing the functionality and useful life of products. We expect a robust 3-year earnings CAGR of 38.7% for 2019-22F, from the bigger wallet share of existing customers and the new application of technology.
• We believe NanoFilm's unique technology provides a strong competitive advantage and warrant a premium to peers.

NanoFilm - Company Background

• NanoFilm Technologies International (SGX:MZH) was founded in 1999 as a high-tech spin-off from NTU. It offers surface solutions based on vaccum deposition, including its own FCVA technology. The group’s production facilities are located in:
  1. Singapore (Singapore Plant);
  2. Shanghai, China (Shanghai Plant 1);
  3. Yizheng, China (held under a JV with CYPR); and
  4. Hanoi, Vietnam (Hai Duong Plant).
• The group is also developing a second plant in Shanghai (Shanghai Plant 2), which is expected to begin initial operations in 1Q21. NanoFilm’s plant in Osaka, Japan, is mainly used to support its nanofabrication business on new nanoproducts and processes through R&D.
• NanoFilm’s main business segments include:
  1. advanced materials (77% of 2019 revenue),
  2. nanofabrication (4% of 2019 revenue), and
  3. industrial equipment (19% of 2019 revenue).
• Click 'view full report' button below to see details on each of the segments in the PDF report attached.

NanoFilm - Industry Outlook

Involvement of surface solutions in smartphones expected to increase.

• Frost & Sullivan estimates growth for the global market size of advanced materials used for smartphones at a CAGR of 7-7.5% between 2020F and 2023F, reaching US$7.5b in 2023F, from S$5.8b in 2019. Advanced materials are typically used for smartphone enclosures, buttons, trims, screws/fasteners, meshes, camera rings and other small parts to impart superior functional and aesthetic properties. The key driver for this segment is the increased demand for 5G-enabled smartphones that incorporate the larger use of materials such as glass, ceramics and plastics in the smartphone bodies. This is to adapt to a new design language which supports the millimetre wave technology.
• Other factors such as the:
  1. increasing size of smartphones (concurrently increasing the surface area for advanced materials usage); and
  2. demand for advanced materials for surface solutions in moving parts (such as hinges) for foldable phones
• are also expected to support the market growth.

Strong growth in wearable and accessories segment expected to continue.

• The market size for advanced materials used for surface solutions in the smart wearables & accessories segment registered a significant 2016-19 CAGR of 56%. The segment growth is driven by the rising demand for functional properties in the internal components of compactly-designed wearables such as smartwatches, wristbands or fitness trackers, hearables and smart rings. Frost & Sullivan expects this to continue, with the segment registering a CAGR of 18% between 2020F-23F. It estimates that the volume of smartwatches, which holds the largest market share for total smart wearables, reached 69 million units in 2019.
• The current market leader for smartwatches is Apple, which holds approximately 45% volume share, followed by Samsung (12%) and Fitbit (11%). The fastest-growing sub-segment in the wearables market is hearables, led by Apple’s AirPods which sold nearly 60 million units in 2019.

NanoFilm's Earnings Outlook

Strong growth from 3C industry.

• NanoFilm’s net profit growth of 22% y-o-y in 2019 and 62% y-o-y in 1H20 was mainly driven by the 33% y-o-y and 67% y-o-y revenue growth from the advanced materials business segment. The fastest growing end user segment for its advanced materials business segment is the 3C (computer, communication and consumer electronics) industry. These include wearables & accessories (2017-19 revenue CAGR of 38%), computers (desktops, laptops and tablets) (2017-19 revenue CAGR of 19%) and smartphones (2017-19 revenue CAGR of 11%).
• More importantly, 1H20 was a key juncture as NanoFilm's revenue from smartphone and wearables & accessories customers more than doubled on a y-o-y basis.
• In addition, NanoFilm's net margin in 1H20 rose by a respectable 3.1ppt to 23.7% (compared to 20.6% in 1H19) on the back of an improvement in operating leverage and a 0.9ppt expansion in gross margin.

Potentially robust 2H20.

• As customers in the 3C industry (the group’s largest end user segment by revenue) prepare for product launches ahead of the holiday season in December, demand for NanoFilm’s surface solution and nanoproducts generally tend to ramp up in July, and such heightened demand would last until December. As such, the group typically enjoys significantly better results in the second half of the year with 2H19 revenue forming 61% of full year revenue (2H18: 61.4% and 2H17: 70.4%).
• Concurrently, with better operating leverage, earnings in the second half of the year typically experience a greater seasonality impact (compared to revenue) with 2H19 earnings forming 68% of full year earnings.
• As its key client (customer Z) has recently launched a series of new products (smartphones, wearables & accessories and tablets), we anticipate a similar seasonality trend for 2H20. With that, we expect 2020F core earnings (ex-listing expense) to grow by 59.5% y-o-y.

Net profit CAGR of 38.7% in 2019-22F.

• We expect NanoFilm to achieve a robust 3-year earnings CAGR of 38.7% for 2019-22F (59.5% in 2020F, 34.8% in 2021F and 24.0% in 2022F). This is led by:
  1. continued revenue growth from advanced materials customers in the smartphone and wearables & accessories industries;
  2. ramp-up of the group’s recent JV with China’s largest piston ring maker, Asimco Shuanghuan Piston Ring (Yizheng) (CYPR); and
  3. ramp-up of its nanofabrication business in Vietnam through its 90% owned subsidiary, NanoFab Technologies (NFT).
• NanoFilm also looks to capture more of its customers’ value chains across various end user industries by offering one-stop solutions.

Main growth driver from increased market share and winning of more parts.

• NanoFilm stands to benefit from recent launches of 5G-enabled smartphones which could spark:
  • a meaningful upgrade cycle;
  • a premiumisation trend; and
  • a change in design language
• which could lead to a growing involvement for surface solution providers such as NanoFilm.
• We expect the main growth driver to come from increased market share and winning of more parts. Other growth areas include the smart wearables & accessories market (NanoFilm’s largest revenue contributor), which has a relatively low penetration rate and is expanding rapidly. This is evident through smartwatch market leader, Apple’s wearables, home and accessories revenue that has grown at a CAGR of 30% between FY16 and FY19. Apple has the highest volume share in the smartwatch market.

Ramp-up of auto JV.

• NanoFilm could also enjoy higher sales from its automotive customers on the back of a potential ramp-up of the group’s JV (51% stake) with China’s largest piston ring maker CYPR, which was established in 2019. NanoFilm is currently the only supplier providing coated piston rings to meet CYPR’s requirements. With the recent JV, revenue from its advanced materials customers in the auto industry rose from S$0.4m in 2018 to S$2.6m in 2019. It has also continued the growth trajectory, with revenue increasing to S$4.8m in 1H20.

Potential entrant into the electric vehicles market.

• In the medium term, NanoFilm could potentially establish a presence in the electric vehicles market by providing surface solutions using its advanced materials (that are more cost effective compared to the conventional gold plating method) for bi-polar plate electrodes in fuel cells.

Ramp-up potential of nanofabrication business in Vietnam.

• NanoFilm’s nanofabrication business started in 2018 when it acquired a majority stake in NanoFab Technologies (NFT), a nanofabrication technology start-up with R&D functions in Japan and product operations in Vietnam. It presently owns a 90% stake. The utilisation rate for its injection moulding equipment is relatively low at 39% and 30% in 2019 and 1H20 respectively. This is because NFT was still in a start-up phase when NanoFilm had acquired it. Thus, it has not reached mass production.
• NFT’s operations were primarily driven by the development and engineering of toolings and moulds in 2018 and 2019. Management shared that it will be in a position to secure mass volume purchase orders and commence nanofabrication of nanoproducts at a mass product scale once its development and engineering of toolings and moulds are granted customers’ acceptance.

Second plant in Shanghai to support growth.

• NanoFilm is in the midst of constructing its second Shanghai plant (situated adjacent to Shanghai Plant1), which will be used to provide surface solutions and manufacturing of coating equipment. Operations at the plant will commence in stages, with initial operations starting in 1Q21. The plant, which is expected to be fully operational by end-21, will be able to house 200 more coating equipments (potentially increasing its total number of coating equipments as at 1H20 by 2.6x from 122 to up to 322 units).

NanoFilm - Investment Highlights

Differentiated technology-based solutions provider with strong competitive edge.

• NanoFilm’s differentiated technology-based solutions, especially in the field of vacuum coating, has enabled its blue chip customers to achieve greater user life, enhanced aesthetics and functionality (eg energy efficiency, corrosion resistance adhesion and hardness) in their end products. NanoFilm has 48 patents in China and Singapore, and 20 pending patent applications in China and Europe. It is also a member of the international Patent Cooperation Treaty.
• According to Frost & Sullivan, NanoFilm’s patented filtered cathodic vacuum arc (FCVA) technology is capable of deposition at room temperature. It is also considered to be superior in film density, surface adhesion, hardness, strength and repeatability in comparison with existing technologies such as physical vapour deposition (PVD) (sputtering) and chemical vapour deposition (CVD).
• Frost & Sullivan also highlighted that the group’s TAC-ON advanced material is among the hardest materials and it has a fairly high quantity of sp3 compared to other diamond-like carbons. These qualities prolong the end products’ durability and lifespan, as well as enhance their attractiveness.
• In addition, FCVA’s ability to deposit advanced materials on substrates at room temperature opens up new markets (such as personal grooming, new energy, 5G, biomedical and aerospace industries) that were previously inaccessible by conventional coating technologies. This has afforded NanoFilm a superior net margin of around 25% vs the industry average of 12% in 2019.
• NanoFilm’s unique technology has enabled 90% of its Top 10 customers (comprising four direct customers and 5 end customers) to rely on it as the single source supplier. The group has close to 300 customers globally across a number of different industries. In addition, the group has long-standing relationships with industry leaders and blue chip names. Notably, Fuji, Nikon and Canon have been clients of the group for the past 13-15 years. In the last five years, NanoFilm has been a supplier to software giant Microsoft (for its surface tablet logos and is responsible for the end-to-end production of each logo) and top global smartphone maker Huawei Technologies.

High growth prospect from bigger wallet share and new application of technology.

• We expect NanoFilm to achieve a robust 3-year earnings CAGR of 38.7% for 2019-22F (59.5% in 2020F, 34.8% in 2021F and 24.0% in 2022F). This would be driven mainly by increasing revenue from existing customers as NanoFilm is aiming to be a one-stop solution provider.
• Meanwhile, the company is exploring the application of its technology in other new industries, including biomedical, IoT and medical implant. In addition, most of its key customers are in the industry with good growth prospects, including:
  1. smartphones (5G implementation, replacement cycle and premiumisation trends);
  2. wearables (smartwatch band’s demand for nanotechnology solutions);
  3. computers (new application such as hinges);
  4. automotive (other engine components such as fuel cells); and
  5. nanofabrication (demand for optical lenses and sensory components).
• Notable key user segments that have contributed to NanoFilm's revenue growth include wearables & accessories (2017-19 CAGR: 38%) and computers (desktops, laptops and tablets) (2017-19 CAGR: 19%).

Positive industry outlook.

• The global market size for advanced materials is expected to grow at a CAGR of 7.5% between 2020F and 2023F, according to Frost & Sullivan. This is driven by the growth in the key end use segment for advanced materials such as smartphones, wearables and automotive. Frost & Sullivan also estimates that the global market size for nanoproducts will register a 2020-23F CAGR of 11% reaching US$7.8b in 2023F.

NanoFilm - Valuation & Recommendation

• We value NanoFilm based on PEG of 0.9 (based on 3-year CAGR of 38.7% which implies a PE of 34.8x 2021F.
• Further improvement in NanoFilm’s profitability track record and wider analyst coverage should help the company to rerate upwards.
• NanoFilm’s unique coating technology has enabled it to enjoy sole supplier status for 90% of its major customers. We believe the company’s proprietary technology, heavy emphasis on R&D and ability to build its own coating machineries have helped to build a high barrier of entry from competitors. In addition, NanoFilm’s competitive advantage has been reflected in its superior net margin of around 25% vs the industry average of 9.6% for 2019.
• Continue to read the PDF report attached below for more details on NanoFilm's valuation and comparison with peers e.g. 3M, PPG Industries, CMC Materials, etc,

Source: UOB Kay Hian Research - 26 Nov 2020