Result

• Core earnings below our expectation. V.S. Industry (VS) registered 2QFY17 core net profit of RM30.0m (after excluding forex gain of RM7.2m during this quarter), up 4.1% yoy but down 11.2% qoq. Cumulatively, the Group chalked up RM63.8m core earnings for 1HFY17, accounting for 39% of our full year forecasts and 41% of consensus. We deem it as below expectations albeit expecting stronger 2H. The weaker-than-expected results were mainly due to lower margins achieved coupled with higher effective tax rate and minority interest against forecasts.

Comment

• Higher yoy whilst lower qoq. VS achieved better yoy results in 2QFY17 mainly attributable to higher contributions from its Malaysia (topline: +41.4%, bottom line: +44.0%) and China (topline: +76.6%, bottom line: +291.7%) operations amid lower contribution from Indonesia operation (PBT: -28.6%) which was affected by higher operating expenses. Meanwhile, the Group achieved weaker qoq results as earnings were affected by minority interest with its stake in China operation despite higher revenue and gross margin achieved.

• Weaker 1H expected. For 1HFY17, the Group recorded lower core net earnings of 18.3% yoy mainly due to high start-up costs in Malaysia operation which pulled down its overall gross margin by 2.6 ppts to 14.7%. The higher operating costs in Malaysia operation were owing to additional labour, hiring and training costs as well as setup costs for the plant for the upcoming sizeable box built order from its existing major customer. The higher effective tax rate during 1HFY17 in the absence of export tax incentives also weighed on the earnings.

• Stronger 2HFY17. We expect a stellar 2HFY17 underpinned by pick up in production volume and better efficiency in its Malaysia operation. On the China side, the Group is expected to sustain its robust performance banking on higher utilization rate in its production lines with the commencement of mass production of a new product to a key customer in China arising from encouraging sales from end consumers.

• Proposed second interim dividend of 1.2 sen/share. VS has proposed an interim dividend of 1.2 sen/share for this quarter which will go ex on 26 April 17. Thus, this brings the total dividend to 2.4 sen/share for 1HFY17 which is higher than 2.3 sen/share in 1HFY16

Earnings Outlook/Revision

• We fine tune our earnings forecasts by lowering FY17F core net profit by 8.0% to RM150.0m whilst nudging up FY18F core net earnings by 1.7% to RM196.7m. This is following our adjustment to the Group’s sales and margins for Malaysia and China operations as well as effective tax rate and minority interest accordingly.

Valuation & Recommendation

• Maintain BUY on VS with a higher target price of RM2.00 (from RM1.68) after rolling over valuation to FY18F. Our fair value is now based on 14x FY2018F PE (historical peak PE) with diluted EPS forecast of 14.3 sen.

• We favour the stock as it is: a) a leading local Electronics Manufacturing Services (EMS) provider with production facilities across Malaysia, Indonesia and China, which enables the Group to tap larger market share and benefit from economies of scale; b) capable to offer vertical integrated full-fledged services to its major client, a distinct advantage to its peers in Malaysia; c) commendable future core earnings growth, +36.2% for FY17F and +31.1% for FY18F; d) strong order pipeline from its existing customers; e) potential orders from coffee brewer business in Asia following the acquisition of JAB Holding Company (parent company of Keurig Green Mountain) on Singapore-listed Super Group which signals the expansion of JAB in Asian coffee and beverage business; f) sturdy balance sheet with low net gearing of 0.2x and its strong operating cash flow; and g) potential synergy from its investment, 12.1% stake, in Seeing Machines Ltd on the back of strong prospects in advanced technology evolved in automotive sector after witnessing Intel’s pricey purchase of Mobileye.

Source: JF Apex Securities Research - 29 Mar 2017