· Weak share prices reflect the mediocre 2Q15 results. Recall that its share price has taken a hit and closed at RM2.80 (-19%) since the beginning of August. We believe this is due to the mediocre 2Q15 results where its quarterly profit was only RM10.0m, bringing 1H15 NP to RM19.3m (-20%) which made up only 32% and 36% of our and the consensus FY15E NP, respectively. Recall that the main negative deviations were due to the much weaker MVS-T sales with customer putting on hold their capital investment as well as higher taxation in 2Q15 (at 26% of PATAMI) after the expiry of its pioneer status on 1st April 2015. Taking a glance back at its YoY results, 1H15 revenue declined by 18% mainly due to lower demand of MVS-T (6 units in 1H15 vs. 30 units in 1H14). While PBT registered a narrower drop of 7% with margins boosted by favourable currency translation, NP came in weaker by 20% dragged by higher effective tax rate. QoQ, the group’s revenue increased by 17% driven by stronger sales across all its segments (MVS, ABI and ECS). Meanwhile at the bottomline, despite the much higher tax expenses, 2Q15 NP still grew by 7%.

· Better 2H2015 performance should make up for the shortfall in 2Q15. We understand from the management that demand for its Machine Vision System (MVS) and Automated Board Inspection (ABI) are recovering from 2Q15 with sales orders coming from Original Equipment Manufacturers (OEM), Electronics Manufacturing Services (EMS) providers and Contract Manufacturers (CM) from several countries. On the group’s MVS segment (contributed 27% to the group’s YTD total revenue), its order backlog for MVS-S stands at 311 units (3 months) which is much stronger than 2Q15’s 288 units, potentially translating into revenue of RM11m-RM13m in 3Q15. Meanwhile on its MVS-T segment which was the drag in the 2Q15’s results, management expects to deliver 5-7 machines in 3Q15 as opposed to only 1 unit in 2Q15; hence, we reckon that the revenue from this segment should normalize back to the level (at c.RM4-5m) seen in 1Q15 vs. 2Q15 (RM1m). MVS-T orderbook and forecast meanwhile are flat with 4-5 machines in the next 1-2 months. Meanwhile on its ABI segment (contributed 70% to the group’s YTD total revenue), we gather that the backlog stands at RM11m as of end July. Meanwhile, 3Q15 orders are expected to be at least c.RM25m with revenue of at least c.RM22m, all on the back of orders from EMS players and new OEM and CM account from Europe, Japan and Malaysia. On the other hand, in its ECS segment (which contributed a mere 2% to the group’s YTD total revenue), demand for its motion and sensor solution are expected to remain soft. Over the medium term, we are also sanguine on the group’s outlook as we understand that there will be replacement demand for c.400 units of AXI in the market over the next 3 years, of which the group is currently expanding its capacity through its CAMPUS 2.0 to cater for the potential sales.

· New Pioneer Status to reduce tax rate from FY2016. Recall that the group’s previous pioneer status had expired on 1st April 2015, causing a bump in taxation in 2Q15. The good news is that a new Pioneer Status has been approved in June 2015 for which VITROX is eligible for 100% tax exemption for 10 years until 2024. Nonetheless, we understand that the company could only enjoy the full tax exemptions starting as soon as 4Q15 after the products comply with the requirements as stated by MIDA. Hence for now, we assume a corporate tax rate of 13% for the full year of FY15 before minimal taxation assumption in the FY16.

· Still maintaining a solid balance sheet and healthy cash flow to support its dividend payout. The group is still at a zero gearing position with strong net cash of RM72.3m as of Jun 2015. Historically, VITROX has been consistently paying out >20% of their earnings as dividends, though its dividend payout policy is only 20% of NP. With the strong balance sheet as well as the consistent dividend payout >20%, we believe the group could pay FY15E/FY1615E DPS of 6.3sen/7.4 sen, translating into dividend yields of 2.3%/2.7% (based on conservative DPR of 30%).

· Trading Buy with a lower Fair Value of RM3.48 (from RM3.84). We lowered our FY15E/FY16E NPs by 17%/14%; with lower sales assumption of MVSS/ MVS-T/ABI by 20%/56%/24% to be partly offset by higher USD/MYR assumption of RM3.80/RM4.00 in FY15E/FY16E (previously at RM3.57/RM3.80). Hence, our revised FV now is RM3.48 based on a targeted rollover FY16E PER of 14x. Maintain Trading Buy as we see value emerging at an undemanding valuation of 11.3x FY16 PER following the share price weakness.

Source: Kenanga Research - 1 Oct 2015