Investment Highlights

• We maintain our BUY recommendation on V.S. Industry (VSI) albeit with a lower fair value of RM1.13/share (previously RM1.50/share), pegged to an FY21F PE of 14x.

• We cut our FY20F–FY22F forecasts by 18–25% to account for the impact of the Covid-19 pandemic on the group’s operations for 2HFY20, particularly that of its Malaysian operations as production was halted due to the movement control order (MCO). Additionally, we account for expectations of weaker order flows overall.

• VSI’s 2QFY20 core profit was below expectations at RM28mil, bringing 1HFY20 core profit to RM78mil. This is after excluding net one-off gains amounting RM3mil which were mainly from unrealized forex gains.

• Although the 1HFY20 results accounted for 48% of our fullyear forecasts and 45% of consensus’ estimates, we consider it to be beneath expectations as we have cut our forecasts for the remainder of FY20.

• 1HFY20 core profit fell by 6% YoY due to revenue declining by 12% YoY amid lower sales orders for its Malaysia and China operations. This was offset by: (i) lower effective tax rate as group PBT was higher due to narrower LBTs seen for both its overseas operations; (ii) lower net finance costs; and (iii) the effect of stripping out an exceptional gain of RM3mil vs. RM5mil loss mainly from unrealized forex losses and loss on disposal of its subsidiary in 1HFY19.

• On a QoQ basis, 2QFY20 core profit plunged 43% due to: (i) 23% lower revenue as sales orders declined across the group, particularly that of its Malaysian operations which dropped by 25% on lower printed circuit board (PCB) orders and as one of its key customer’s products is at the end of its product life cycle; and (ii) group PBT falling 32% due to the previous reason as well as less favorable forex rates impacting its Indonesian operations; and (iii) higher effective tax rate.

• Segmental analysis for 1HFY20 (YoY):

o Malaysia: PBT slid 5% in tandem with a 10% decline in sales orders from its key customers.

o Indonesia: Revenue was up by 0.8% which helped to narrow the segment’s LBT which still suffers from underutilization of production capacity.

o China: Decline in sales orders led to a 34% lower revenue, but LBT narrowed to -RM7mil from -RM24mil due to lower operating expenses following VSI’s costoptimization initiatives.

• Updates relating to the Covid-19 outbreak:

o Malaysia: On 16 March 2020, Malaysia announced a 14-day MCO from 18 to 31 March 2020, where government and private premises would be closed except for those providing essential services e.g. utilities, health, transportation, etc. Then, on 18 March 2020, after a meeting with industry associations, the National Security Council (NSC) issued a statement allowing manufacturing industries to continue operating under certain conditions during the MCO, subject to the approval of the Ministry of Trade and Industry (MITI). The conditions are set in Exhibit 3.

The list of approved critical manufacturing sectors includes the electrical & electronics (E&E) sector, which VSI falls under. However, upon checking with VSI, the group is still waiting for MITI’s approval and its Malaysian operations have been put to a halt since the MCO was announced. Furthermore, the MCO has been subsequently extended to 14 April 2020. If the group does not obtain MITI’s approval, its Malaysian operations would be shut for a total of 28 days, which would have a huge impact on the group’s performance as the segment contributes 85% of group revenue.

o Indonesia: The segment has seen minimal impact and overall impact to group would be lesser due to the segment’s 8% contribution to group revenue. VSI is hopeful for its Indonesian operations to remain profit-making, assuming that the outbreak in Indonesia does not worsen drastically.

o China: Its operations had been halted during the extended Chinese Lunar New in efforts to contain the Covid-19 outbreak but began resuming production mid-February 2020. We gather that roughly 70% of production workers have returned by mid-March 2020. The facility has been underutilized due to lower sales orders even prior to the virus outbreak, thus we expect minimal impact as we anticipate that any order backlog would be able to be fulfilled due to its available production capacity. The segment contributes 7% of group revenue in 1HFY20.

o VSI’s supply chain: The pandemic had caused VSI’s supply chain to experience delays as material shipments from suppliers in China were disrupted. However, factories in China are now catching up on production after resuming operations in mid-February 2020. The group’s Malaysian segment imports 30% of its raw materials from China, but VSI had inventory up till early March 2020. Thus, we expect only a slight delay in raw material procurement. We are more concerned of the uncertainties on the demand side as the Covid-19 impacts the markets of VSI’s key customers.

o Negotiations with prospective customers: Discussions with its prospective customers have been suspended due to travel restrictions amid the Covid-19 outbreak.

• We reiterate our BUY recommendation on VSI despite its near-term outlook being clouded by Covid-19 effects, as we believe that the recent sell down has opened up opportunities to collect the stock at attractive valuations. The group’s positive longer-term prospects arise from: (i) the resilience of its domestics sales due to its association with its key customer and Bissell with new product launches slated over the next few years; (ii) its ability to offer turnkey EMS solutions by being a vertically-integrated player; (iii) narrower losses from its China operations due to cost optimization and streamlining efforts; and (iv) its diversified customer base with potential opportunities to be secured from the US-China trade war diversion.

Source: AmInvest Research - 27 Mar 2020