We left yesterday’s briefing feeling upbeat about its outlook. The newly awarded contract of RM200m for motorised items Customer X is on track to start running in Dec 2020. The big jump in contribution will come from US Customer with total of 9 models contributing RM900m to FY21 top line (vs RM150m in FY20). VSI is also benefiting from the change in consumer behaviour attributable to the new normal of homebound population with upward projection on coffee brewer and pool cleaner. Reaffirm BUY recommendation with unchanged TP of RM2.70 pegged to PE multiple to 17x to CY22 EPS.

Recap. VSI’s core PATAMI of RM57.9m (3QFY20: -RM15.2m; YoY: -4%), brought FY20 sum to RM121m (-32.1% YoY). This made up 120% of our full year forecast and 129% of consensus’. The impressive showing was attributable to superior margin recorded.

Customer X. Revenue from Customer X decreased RM1bn mainly due to plant closure during MCO in Malaysia. Despite that, we are assured with VSI proactive measures in reducing reliance on Customer X. The newly awarded contract of RM200m for motorised items is on track to start running in Dec 2020. This should be able to offset the drop in revenue for battery pack that yielded lower margin.

US Customer is ramping up faster than initial expectation. To recap, VSI successfully signed US Customer’s floor care product in Mar 2019, which was previously manufactured by two China-based EMS. VSI has started the production for 3 models and is expected to roll out 2 more models by Dec 2020 and the remaining 4 models in FY21. Total of 9 models from US Customer will contribute RM900m to VSI’s FY21 top line (vs RM150m in FY20). Projection is expected to be positive and VSI could potentially secure a total of 12 models with revenue contribution of RM1.3bn for FY22. Note that the margin contribution from US Customer is higher than the UK’s.

Victory. Carlyle Group, a global investment firm with USD221bn AUM, announced on 16 Sept that they are acquiring majority stake in Victory Innovations. Note that Victory is VSI’s latest customer on board in Aug with RM600m contract secured for CY21 and contribution is expected to be in an upward trend to RM1.4bn and RM1.5bn for CY22 and CY23, respectively. Management reaffirmed that this acquisition should not interfere with VSI business as Carlyle has a long standing relationship with VSI through the pool cleaner customer. Carlyle previously owned a pool cleaner customer in 2007, but subsequently sold the company in 2016. When VSI started production for the pool cleaner in 2014, they managed to prove their capability by lowering the reject rate to 3% from 20%.

Benefiting from the new normal. The change in consumer behaviour of the homebound population has led to a sudden demand spike for coffee machines, on top of strong orders to stock up for Christmas and year-end sales. This was mainly due to the lockdown measure that has been put in place that caused most consumers to opt in buying their own coffee machines. Contributions are expected to increase to RM700m in FY21 (vs RM400m in FY20). Similarly, pool cleaner customer is also projecting an upward trend with FY21 contribution to increase by 50% to RM300m from RM200m in FY20. Note that this customer contributed the highest margin among others.

China. Save for impairments, China recorded positive PBT of RM1.8m in 4QFY20 vs -RM27.3m in 4QFY19 on the back of lower operating expenses with the adaptation of asset-light business strategy. Management shared that the group is projecting a narrower loss for FY21 by maintaining high-profit-margin customer and subsequently phased out those with low margins. As for the land in Zhuhai, though the negotiations to monetize the asset have been ongoing for quite some time, no firm conclusion has been arrived at this juncture. 

Still pending on the long awaited announcement. Signs of a turnaround for VSI have become more visible in 4QFY20 with highest core PAT margin recorded (6.6%) in the past 4 years. Barring any unforeseen circumstances, a steady recovery is anticipated, on account of active negotiations with 5 prospective customers that we understand are in the final stages of discussion. Should another partnership materialize, VSI is looking to buy another RM400k sqft plant to support this growth as they are expected to operate in full capacity by FY21. Case in point, assuming RM600m contract secured (similar to Victory’s size) with full contribution in FY22, a conservative core margin of 5.8% would lift up our FY22 earnings projection by 15% and 22 sen increase to our TP.

Forecast. We keep our forecast unchanged, as the management guidance is in line with our projection.

Reaffirm BUY, TP: RM2.70 pegged to unchanged PE of 17x to CY22 EPS. We view the premium PE multiple is justifiable taking into account of VSI’s multi-year growth trajectory from existing customers coupled with the proven capability to secure more projects that yield higher margins in the near future. As the biggest EMS player in Malaysia with solid track record, we opine that VSI is on trajectory to achieve new high order value amongst the intensifying trade diversion.

Source: Hong Leong Investment Bank Research - 2 Oct 2020