• Volume Growth Outlook for Most Key Customers Remains Intact
• Revenue contribution of its pool cleaning customer could double by FY23, but Victory’s outlook has turned grim
• Cut FY21-23 EPS forecasts by 5-13% on lower Victory volumes. Reiterate BUY with lower TP of RM3.80 (from RM4.20)

Without a Battle, There Is No “Victory”

To recall, VSI secured Victory as a customer in August 2020 during the pandemic, and had intended to start with 2 models (cordless electrostatic sprayer) that were to have commenced production in 1QCY21. The production of the first model is now expected to commence sometime in 2HCY21, but the client has decided to use its previous contract manufacturer (CM) in China for the other model. This poses some earnings downside risk with the previous revenue guidance for the two models of around RM300m (vs our revised projection of RM200m).

Higher Orders From Pool Cleaning Customer

Orders from its US and UK-based ‘Customer X’, and its coffee brewer customer, remain largely intact. Production for its US-based customer is progressively being ramped up with one model having started in March, and another in April 2021. Production for the most recently secured ‘Customer Y’ is expected to commence sometime in June-July 2021. The company is projecting revenue from its pool cleaning customers to double by FY23 on higher orders and more new models.

Cut Our FY21-23E EPS by -13%/-5%/-5%

We cut our earnings forecasts after lowering the revenue assumptions for Victory to RM200m/RM400m in FY22-23E (from RM700m/RM825m), and reflect the delay in the new model production by lowering the revenue contribution in FY21. The lower revenue would be partly cushioned by higher volume projection for the pool cleaning customers at RM300m/RM400m/RM500m (from RM250m/RM305m/RM337m) across FY21-23E.

Lower 12-month Target Price of RM3.80; Buy Rating Unchanged

Post the earnings forecast revisions, we lower our target price to RM3.80 (from RM4.20), pegged to an unchanged 26x CY21E EPS. We reiterate our Buy recommendation. Despite the setback in near-term prospects regarding Victory, we remain positive on VSI securing new clients and orders given its most diversified customer base.

Victory Retained 1 Model With VSI, Directing the Other to Original CM

VSI losing out on a new model has raised concerns over whether the existing model will be withdrawn by Victory as well. We gather that the client has decided to divert one model to its previous CM in China, after it resolved the issue to ramp up production. While it is hard to ascertain the future, we are assuming the base case that VSI will continue working on one model with RM200m revenue assumption for FY22 and RM400m for FY23 on the expectation of better demand (vs. our previous forecasts at RM700m/RM825m).

Forecast 19-30% EPS Growth in FY22-23E

Despite the dampened near-term outlook due to Victory, we expect FY21E revenue and core net profit to register 32% and 62% yoy growth, driven by strong sales demand from existing customers, and supported by the production of new models. For FY22-23E, we expect revenue to grow 14-19% yoy driven by full-year contribution from the production of these new models and the expectation of more new models being awarded. This coupled with the gradual margins improvement going forward from a better customer mix should drive the 19-30% EPS growth over FY22-23E.

Earnings Rebounded Strongly in Recent Quarters…

After registering a core loss in 3QFY20 as a result of factory closures at the peak of the pandemic, net profit over the past three quarters have rebounded strongly at RM58-67m driven by robust orders from existing customers and a gradual production ramp-up of new models from newly secured clients.

…but Expect Slight Dip in Upcoming 3QFY21 Results

However, we expect softer sequential earnings for 3QFY21. To recap, VSI received instructions from Ministry of Health (MOH) to shut down three of its factories in Senai from 11-17 February 2021 to carry out deep cleaning and disinfection work. We expect the 7-day factory closures, and a seasonally slower quarter to negatively impact revenue and earnings. Its China operations had a commendable 2QFY21 with the loss before tax narrowing to RM0.6m (from RM5.5m in 1QFY21), but losses could widen in the coming quarter on higher costs.

Lifting FY21E Capex to RM200m

We raise our FY21 capex to RM200m (from RM150m). This would be split into RM100m for new land acquisition, RM50m for equipment upgrade and the remaining for normal maintenance. The high capex spending would be proportionate to the aggressive profit growth we expect (+62% yoy) for FY21. We expect the FY22 capex to normalize at the RM100m level, unchanged from our previous forecast.

Looking to Acquire More Land for Capacity Expansion

We gather from AME Elite’s most recent analyst briefing that VSI is in the midst of negotiating for another piece of land to further expand its capacity. This follows the previous six pieces of land (414k sf) VSI had acquired in October 2020, which are targeted to be ready by June 2021 and fully taken up by ‘Customer Y’. While the new land acquisition is still at the preliminary stage of discussion with no indication of size, we gather that the future capacity will be allocated partly to more new models of its pool cleaning customers and prospective customers. We have factored in RM450m/RM900m new order wins for FY22-23E.

Valuation and Recommendation

EMS Remains a Preferred Growth Sector

Post the earnings forecast revisions, we lower our 12-month target price to RM3.80 (from RM4.20), pegged to an unchanged 26x CY21E EPS. We believe the EMS sector deserves to trade at a premium valuation on the back of the scarcity of growth sectors in Malaysia. Despite the short-term setback in Victory’s orders, we remain confident of the overall sector prospects with the expectation of more global manufacturing companies moving their supply chains out to Malaysia, with VSI being the biggest beneficiary due to its most diversified customer mix. We reiterate our Buy rating.

Key Downside Risks

These include any further cut in existing customer orders, lower-than-expected margins arising from the new production line start-up, unexpected factory closures from another virus outbreak, and worsening global economic environment leading to weaker demand for consumer appliances.

Source: Affin Hwang Research - 19 Apr 2021