Result

• Earnings below expectations. V.S. Industry (VS) posted a core net profit of RM12.2m for its 3QFY18 results (after excluding net forex gain of RM11.7m during the quarter), which slumped 76.0% yoy and 68.9% qoq. Likewise, the Group achieved lower 9MFY18 core earnings of RM95.6m, down 16.7% yoy. The results are below expectation, accounting for 47% of our full year estimate mainly due to lower-than-expected margins achieved although 9M revenue accounts for 74% of our topline forecast. Meanwhile, 9MFY18 headline net profit of RM112.4m constitutes 57% of consensus.

Comment

• Disappointing 3Q. In a negative surprise, VS recorded significantly lower yoy and qoq results. The weaker yoy results were mainly attributable to lower GP margin (- 6.9ppts) as a result of higher raw material prices (pursuant to higher resin prices which affected its plastic injection molding, we believe, coupled with weakening of USD against MYR during the quarter) and higher labour costs (foreign worker levy). We witness across-the-board decline in PBT for all of its geographical operations: Malaysian operation (- 56.8% yoy) dragged by higher labour costs and failure to attain operational efficiency for its box-built assembly lines, as well as set-up and testing costs associated with an upcoming new production line; Indonesian operation was in the red due to underutilization of production capacity; and China operation (-71.2% yoy) was affected by lower sales and higher operational costs. Similarly, the weaker 9M results were due to the abovementioned reasons as its GP margin tumbled 4.5ppts amid higher revenue achieved, +34.0% yoy.

• Weaker qoq. On a qoq basis, the Group, again, posted a lower net profit on the back of lower revenue recorded (- 21.0% qoq) coupled with higher operating costs as mentioned above. The lower topline was mainly due to drop in sales orders from its US-based customer, Keurig following the planned discontinuation of certain products that had reached its end of product lifecycle.

• Proposed 3rd interim dividend. VS has proposed a 3rd interim dividend of 0.5 sen/share for this quarter, bringing its 9MFY18 dividend to 3.5 sen/share, which is lower than 3.9 sen/share declared during 9MFY17.
• Challenging short-term outlook. The Group’s topline will continue to be driven by the box-built orders from its key customer. However, for its bottomline, we only envisage its margin for local operation to improve gradually with the new production lines that came on-stream to reach optimal production level progressively. Also, start-up costs for new upcoming lines could continue to weigh on its gross margin coupled with higher labour costs and fluctuations in forex. Meanwhile, the Group expects its sales to Keurig to pick up gradually in the upcoming quarters with the production of new replacement model.

Earnings Outlook/Revision

• We slash our core net profit forecasts for FY18F and FY19F by respective 39% to RM123.0m and 29% to RM190.4m to better reflect its weaker margin.

Valuation & Recommendation

• Maintain HOLD with a lower target price of RM1.41 (RM2.22 previously after adjusting for bonus issue) following our earnings downgrade and ascribing lower PE multiple. Our valuation is now based on FD PE of 13.5x FY19F EPS. We lower the valuation of the stock as we believe the current share price has priced in the potential orders, to a certain extent, whilst immediate outlook is fazed by the escalating raw material and operating costs as well as volatility in forex.

Source: JF Apex Securities Research - 29 Jun 2018