Result

• Earnings above our expectation but within consensus. V.S. Industry (VS) posted a headline net profit of RM38.4m for its 4QFY18 results, up 4.3% yoy and 82.0% qoq. However, for the full year of FY18, the Group achieved lower reported net earnings of RM150.8m, slightly down by 3.5% yoy. The results are above our expectation, accounting for 108% of our full year estimate mainly due to stronger-than-expected 4QFY18 as a result of lower effective tax rate and positive minority interest (MI).

Comment

• Worst is over with rebound of 4QFY18 results. The slightly better yoy performance was mainly due to significantly lower effective tax rate (4QFY18: 5.2% vs 4QFY17: 25.5%) as a result of utilisation of reinvestment allowance coupled with higher MI (4QFY18: RM14.7m vs 4QFY17: RM1.2m) pursuant to losses in China operation. Similarly, the stronger qoq performance was attributed to lower effective tax rate (4QFY18: 5.2% vs 3QFY18: 23.9%) and positive MI (4QFY18: RM14.7m vs 3QFY18: -RM0.5m) amid lower PBT as dragged by loss on disposal of a subsidiary in China, net forex loss and loss by associates. Notably, we witnessed the recovery in the Group’s GP margin in this quarter, +3.3pts qoq, to 11.7% underpinned by its Malaysian operation as production of new replacement models for its coffee brewer has commenced following cessation of old models in the previous quarter.

• Slightly weaker FY18. Despite achieving stronger top line (+24.6% yoy), VS posted a lower full year net profit (-3.5% yoy) no thanks to margins erosion (GP margin: -3.3pts; PBT margin: -2.5pts) as affected by higher material prices as well as labour cost. The initial setup and testing costs incurred in 1HFY18 for new assembly lines in Malaysia, and lower contribution from its major client in the US in 3Q (cessation of certain models) also weighed on its overall earnings. Furthermore, the lower sales orders, higher raw material prices and labour costs as well as loss on disposal of a subsidiary during this quarter dragged its China operation into loss before tax for this financial year (FY18: -RM19.1m vs FY17: RM17.4m).

• Proposed final dividend of 0.6sen/share. VS has proposed a 4th interim dividend of 0.6 sen/share for this quarter, bringing its FY18 dividend to 4.7 sen/share, which is lower than 5.9 sen/share declared during FY17.

• More new lines coming on stream. On its box-build assembly for one of its major clients, 1 new line has just commenced operation in July 2018 and the Group targets for another new line to come on stream in Nov 2018.

Meanwhile, for its coffee brewer, VS has commenced production of 1 new line in Aug 2018 and plans for another 2 additional new lines in 3QFY19 (Feb-Apr 2019).

Earnings Outlook/Revision

• We lift our net profit forecast for FY19F by 8.2% to RM206.1m (+36.7% yoy) to reflect the profit margin recovery ahead. Also, we introduce our FY20F net earnings of RM238.2m (+15.6% yoy).

Valuation & Recommendation

• Maintain HOLD with a higher target price of RM1.69 (RM1.41 previously) following our earnings upgrade. Our valuation for the stock is now pegged at PE multiple of 15x of FY19 EPS. Whilst we favour the Group for its strong fundamental and anticipated earnings rebound in FY19, we believe its share price has factored in the positives and is deemed fully valued with minimal upside against our target price.

• We are cautiously optimistic on its immediate outlook given: 1) elevated labour costs with more hiring expected, 2) rising operating costs in relation to upcoming new capacities (300k sf of new factories which are able to cater for 20 lines) as box-build assembly lines take time to reach the optimal capacity and the Group is currently looking for prospects to fill up the additional capacity, 3) challenging outlook for China operation in FY19.

Source: JF Apex Securities Research - 26 Sept 2018