What’s New

• Our positive view on the stock is still intact. We have met V.S. Industry (VS) management recently and maintain our bullish view on the Group’s prospects. We are pleasantly surprised with the Group’s ability to bag more orders for its Malaysia and China operations in the near future. Besides, we are impressed with VS’s current automation plans in China which would improve the Group’s productivity and efficiency over the medium to long term.

Comment

• More orders in the pipeline. We believe the Group could secure more new orders from its existing key customer in Malaysia. The additional two new production lines (on top of the two existing completed box-build assembly lines which commenced production as well as the two planned assembly lines which are underway) will be fully commissioned by Oct 17. We believe the 5th and 6th production lines cater for box build assembly of a new product in the likes of beauty product as its patent was being granted recently. Assuming the new order is worth RM200m/p.a. for each line and production is gradually ramped up, we envisage the Group’s topline and bottomline could be boosted by slightly over 5% with earnings starting to kick in 2QFY18 onwards.

• Status of the box-build assembly lines for its major customer. 1st new box-build assembly line is currently running at optimal capacity and 2nd line commenced operation in early Feb 17. Each of the first two lines will render a value of RM400m/p.a. Meanwhile, the 3rd line will commence operation in May 17 and takes 3-4 months to reach optimal capacity. Together with the upcoming 4th line, it will contribute total value of RM300m/p.a. Overall, VS is capable to produce up to 4m units of box-build assembly for this major customer. Box-build segment’s contribution is expected to jump substantially in 2HFY17-FY18 from a meager RM50m revenue in FY16. Management guided that the Group would incur RM40m capex for its Malaysia operation in FY17.

• Higher contributions from PCBA and battery pack this year. In 1HFY17, VS recorded revenue of RM390m for both of its PCBA and battery pack segments. Management envisages to achieve c.RM700m revenue in FY17 which is 7.7% higher than RM650m achieved in FY16. With foreseeable more box-build assembly orders coming in as compared to PCBA job scope, management expects the Group’s gross margin to trend lower from existing 15% in FY17 to 14% in FY18. Nonetheless, the Group still able to sustain its net margin of around 5-6%.

• Keurig’s orders will kick in strongly in 2HFY17. Keurig’s new order (ODM by VS which was secured earlier) has commenced production since end Feb 17. Hence, we would see significant contributions from this new model of coffee brewer to kick in 2HFY17 onwards after seeing weaker 1H contributions. Management targets full year FY17 sales of c.RM700m from Keurig. Furthermore, we expect potential orders for VS for the coffee brewer business in Asia after JAB Holding Company (parent company of Keurig Green Mountain) acquired Singapore-listed Super Group, which signals the expansion of JAB in Asian coffee and beverage business.
   
• China operation having a full plate. The Group’s 43.6% owned, HK-listed VSIG is bustling with orders, particularly for its new air purifier to its client, Perfect China (ODM contract worth RMB400m or RM242m awarded in Aug last year). The new product was well received in China with 170k units of air purifiers being sold within 3 months of launching since Nov 16. Revenue has been booked in 2QFY17 which resulted in strong turnaround of the Group’s China operation against net loss in 1QFY17 whilst PBT quadrupled yoy. The Group expects to fulfil its remaining orders of 80k units in the next 2 months, which is much earlier than expected. Currently, VS is in discussion with the client to replenish orders for probably another 250k units/p.a. worth RMB400m or RM257m. Moving forward, we expect the China contribution to soften in 3QFY17 as management guided that it requires time to procure raw materials for the product before the sales picking up again in 4QFY17 onwards. Notably, VS also expects strong flows of recurring income from the replacement market with its sales of filters for the air purifiers. Meanwhile, for its NEP Diamond water filter, sales in China are pending regulatory approvals, likely to be obtained in mid-CY17. Hence, we expect the manufacturing revenue to come in FY18 onwards with RM200m revenue over the next two years. Also, the Group has embarked on production automation in its China plants to further improve its productivity and reduce labour cost with estimated capex of RMB30m or RM20m.

Earnings Outlook/Revision

• We lift our net earnings forecasts for FY17 and FY18F by 8.5% and 14.6% respectively. This is following our upwards revision to the Group’s sales and margins for Malaysia and China operations. We have factored in the 5th and 6th lines in our FY18 estimate.

Valuation & Recommendation

• Maintain BUY on VS with a higher target price of RM2.27 (from RM2.00) following our earnings upgrade. Our fair value is based on unchanged 14x FY2018F PE (historical peak PE) with diluted EPS forecast of 16.2 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 services, i.e. tooling, plastic injection, PCBA and complete product assembly to its major client, a distinct advantage to its peers in Malaysia; c) commendable core earnings growth of +47.9% for FY17F and +38.5% for FY18F; d) strong order pipeline from its existing customers; e) sturdy balance sheet with low net gearing of 0.2x and its strong operating cash flow; and f) 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 - 10 Apr 2017