Results Highlights

• V.S. Industry Bhd (VSI) posted a 27.5% Y.o.Y gain in its 2QFY18 net profit to RM45.3 mln, from RM35.5 mln in the same quarter last year - in-tandem with the stronger revenue contribution (+45.8% Y.o.Y) of RM1.11 bln vs. RM763.8 mln in 2QFY17 and higher other income as well as lower tax expense. The group has proposed a second interim dividend of 1.5 sen per share (cumulative dividend 3.0 sen vs. 2.4 sen in 1HFY17), which will be paid on 27th April 2018.

• Cumulative 1HFY18 net profit, meanwhile, jumped 32.2% Y.o.Y to RM91.3 mln, from RM69.0 mln a year earlier – led by the aforementioned reasons, while revenue spiked up by 52.3% Y.o.Y to RM2.2 bln, compared to RM1.44 bln in 1HFY17.

• However, the recent 1HFY18 results missed our expectations by 9.6%, accounting to only 40.4% of our previous FY18 forecast net profit of RM226.1 mln, despite revenue meeting 48.5% of our full year forecast. The disparity was mainly due to delays in capacity expansion as well as significantly lower bottomline contribution from the China segment which ultimately crimped margins.

• Despite the hiccups, we think that VSI is still on-track to achieve its positive growth trajectory with a projected three-year net profit and revenue CAGR of 32.4% and 31.6% respectively. Therefore, we continue to like VSI for its leading position in the local electronic manufacturing services (EMS) industry, experienced management team and solid track record, which we think will sustain the group’s earnings growth in the foreseeable future.

Prospects

As expected, VSI’s China-unit showed improvements in 2QFY18, although the upbeat performance was not enough to smooth out the impact of the net loss recorded in 1QFY18, which was dragged down by high raw materials costs. Moving forward, the group’s 2HFY18 results are forecast to be similar to the previous corresponding year which could lead to potentially lower FY18 net profit growth.

In addition, we also foresee minor production delays in the Malaysian operations due to design issues that could weigh on the group’s revenue. Combined with a flat growth from certain key customers this financial year, we adjust our view on VSI’s growth to a less aggressive tone for FY18, although we still foresee a double-digit growth in both its topline and bottomline. Growth is expected to be spurred by cost savings from the acquisition of Skreen Fabric – a component manufacturer of VSI’s products, ongoing automation efforts and upgrades in its production capacity.

All-in-all, we think that the present situation is merely a hiccup in VSI’s strong upward growth trajectory. The positive vibe is also expected to spill over to FY19, on the back of: i) higher sales orders as all new capacity come on-line, ii) normalisation in raw material prices, and iii) ongoing automation efforts.

We note that the group currently has ready resources on-hand to cater to new orders from existing or new customers, if needed. To date, the group has acquired a new factory and completed the construction of a new warehouse (Refer to Appendix 1), while another factory, which is under construction, is expected to be completed by mid- 2018.

Valuation and Recommendation

In-tandem with the lower-than-anticipated 1HFY18 results, we adjust our FY18 earnings and revenue forecast to RM190.7 mln (-15.7%) and RM4.51 bln (-0.5%) respectively, to account for higher start-up costs and thinner margins amid stiff competition in China, increasing prices of raw materials and a stronger Ringgit. Meanwhile, FY19 earnings and revenue estimates were also reduced by 10.9% and 7.4% to RM269.4 mln and RM4.96 bln respectively.

Nevertheless, we reiterate our BUY recommendation on VSI with a lower target price of RM3.25 (from RM3.60) after adjusting bottomline estimates to reflect a more realistic growth following the weaker 1HFY2018 performance. The target price is arrived by ascribing an unchanged target PER of 18.0x to its revised FY19 diluted EPS of 18.1 sen. The ascribed target PER remains at a premium to its closest competitor, SKP Resources, which we believe is justified in view of the group’s leading position in Malaysia’s EMS industry. The premium is also accorded for its wide array of supply chain services and solid earnings track-record, as well as the potentially strong forward earnings growth on offer.

Risks to our recommendations include: i) slower economic growth in the local and global environment that could dampen demand for consumer electronics, which would in turn lead to lower orders, ii) labour shortages which could significantly disrupt the group’s operations due to its labour intensive structure, and iii) higher raw materials prices as well as fluctuations in foreign exchange rate affecting its margins.

Source: Mplus Research - 29 Mar 2018