Result

• Earnings missed expectations. V.S. Industry (VS) registered 1QFY17 core net profit of RM33.8m (after including forex loss of RM0.4m during this quarter), down 31.4% yoy but quadrupled qoq. The lower-than-expected results, accounting for 19% of our full year forecasts and consensus, were mainly due to lower margins as a result of high start-up costs in its Malaysian operation.

Comment

• Lower yoy profit dragged down by Malaysia operations. The Group achieved weaker yoy results mainly attributable to high start-up costs incurred (gross margin down 3.9 ppts to 13.5%) by its Malaysian operations in relation to upcoming sizeable box built order for its major customer, Dyson in 2HFY17 amid higher revenue recorded (+11.0% yoy). VS forked out additional labour, hiring and training costs with new recruitment of close to 1,000 new foreign factory operators during 1QFY17 besides the plant’s setup costs. Meanwhile, the Group’s Indonesian operations chalked up better performance (top line: +41.1% yoy; bottom line: +54.8% yoy) on the back of higher sales and higher margin benefited from economies of scale following an increase in production, whilst its China segment registered losses no thanks to lower revenue coupled with higher costs of raw material as affected by weaker RMB against USD.

• Higher qoq, as expected. The Group performed strongly on qoq basis, underpinned by stellar sales (+22.7% qoq), particularly in Malaysia. The better results were also lifted by the absence of impairment losses, which was incurred in 4QFY16, in relation to its investment in London-listed Seeing Machines Limited and deposit to Inner Mongolia, China.

• Better 2HFY17. While the initial setup costs will continue to weigh on the Group’s 2QFY17 earnings, albeit at a lesser extent, VS envisages a better 2HFY17 underpinned by higher production volume and better efficiency. On its China operations, the Group expects improved performance in the near future as it has since commenced mass production of a new product for a key customer in China and this contributed higher utilization rate.

• Proposed first interim dividend of 1.2 sen/share. VS has also proposed an interim dividend of 1.2 sen/share (against 1.5 sen/share in 1QFY16) for FY17 which will go ex on 24 Feb 17.

Earnings Outlook/Revision

• We reduce our earnings forecasts for FY17F and FY18F by respective 8.2% after lowering our margins in view of rising operating costs.

Valuation & Recommendation

• Maintain BUY on VS with a lower target price of RM1.68 (from RM1.75) following our earnings cut. Still, our target price offers 22% upside to the current share price. Our fair value is now based on 14x FY2017F PE (historical peak PE) with diluted EPS forecast of 12 sen.

• We favour the stock for its: a) commendable core earnings growth, +48.1% for FY17F and +18.6% for FY18F; b) strong order pipeline from Dyson; c) leading local Electronics Manufacturing Services (EMS) provider; and d) sturdy balance sheet with low net gearing of 0.2x and its strong operating cash flow

Source: JF Apex Securities Research - 27 Dec 2016