Investment Highlights

• We upgrade our NEUTRAL recommendation on the Electronics Manufacturing Services (EMS) sector to OVERWEIGHT for the next 12 months as we believe that the positive prospects of manufacturers tied to the production of general household products such as ATA IMS (BUY, FV RM2.02) and V.S. Industry (BUY, FV RM1.48) have been further boosted by: (i) recent job wins; and (ii) the potential to secure additional customers/orders as opportunities arise from the US-China trade war on top of otherwise, organic growth.
   
• Customer diversification efforts fruitful: ATA has managed to secure five new customers namely Sagemcom, Schneider Electric, Swift Labs, ecobee and cricut with the production for all the new customers slated to start in 2020. The group has rented a 250K sq ft site dedicated to these new projects where the facility will be used for plastic injection moulding, final assembly and warehousing. The combined revenue contribution from these customers is expected to be around RM150–200mil in the first year of production but we have maintained our FY21F forecasts for ATA as we have already factored in the topline growth which was in line with guidance. Meanwhile, V.S. Industry (VSI) secured printed circuit board assembly (PCBA) orders from a new customer in July 2019 which is expected to contribute RM200mil revenue in FY20F and a full-assembly customer secured in early October 2019 which will contribute RM100mil revenue yearly. Securing additional PCBA orders partially mitigates the anticipated decline in its current PCBA orders as some of its customers move towards self-sufficiency by producing PCBA in-house. Also recall that VSI secured its agreement with Bissell in March 2019 and now has a 160K sq ft plant equipped with injection moulding facilities, assembly lines, a warehouse and a test lab for the new customer. The group started mass production for Bissell’s first carpet cleaner model in September 2019 and has a total of 5 models confirmed with the other lines for Bissell ensuing once the first line’s production stabilizes. We have forecasted Bissell to contribute around 10–23% of VSI’s earnings from FY20F to FY22F. ATA and VSI are continuing their efforts to secure more customers and/or orders as well as seizing opportunities that arise from the US-China trade war causing diversion of order flows into Southeast Asia. In the long term, both companies target its key customer to contribute around 40–50% of total group revenue to reduce customer concentration risk.
   
• Still seeing strong contribution from its current key customer: On top of ATA’s 14 lines for its key customer, the group has managed to secure an additional two projects in the pipeline, one for a floorcare product to commence production in April 2020 and the other is a light product which has commenced production in end-November 2019, albeit contributing a smaller portion of its key customer’s products. Meanwhile, VSI currently has 4.5 lines running for said key customer, producing a mixture of a personal care product and floorcare products.

• Integrating vertically to attain self-sufficiency and attract more job wins: 4QFY20 is expected to be a key milestone for ATA’s vertical integration efforts as its wire harness capability is scheduled for an audit with the key customer and is expected to start production in the same said quarter while its brush bar assembly is already in production as at endNovember 2019 with plants to ramp up capacity and be fully self-sufficient by 4QFY20. Meanwhile, Microtronics Sdn Bhd’s PCBA and battery pack assembly capabilities, which are slated to be injected into ATA by mid-CY2021, currently have 14 surface mount technology (SMT) lines, and aims to be fully self-sufficient by 4QFY20. The current SMT lines cater to 75% of ATA’s PCBA and battery pack requirements. As for VSI, the group has been a known vertically-integrated player with tooling, plastic injection, PCBA and full-assembly capabilities giving the group an edge over peers who lack PCBA capabilities. However, we note that even SKP Resources (UNRATED) has commenced production of PCBA in 1HCY19 as the EMS sector moves towards being vertically-integrated.

• Potential changes to sector rating: We may downgrade the sector to NEUTRAL if: (i) weakening global economic conditions dampen demand in customers’ products; (ii) labour issues arise relating to labour costs and worker shortages; (iii) sudden loss or orders and/or key customers; and (iv) the overseas operations of certain players worsen if continued deterioration of sales orders plunges further and offset any cost-saving measures taken.

• Our top pick for the sector is ATA (BUY, FV RM2.02) due to its positive prospects arising from: (i) it being the purest proxy to the robust growth prospects of its key customer; (ii) its move to become a vertically-integrated player will put it in a better position to secure orders and/or customers; and (3) its 3-year profit CAGR of 17% for FY19–FY22F underpinned by its modular expansion strategy. We are also positive on its move to venture into production for Internet of Things-related (IoT) products through the securement of its five new customers.

Source: AmInvest Research - 17 Dec 2019