This article first appeared in The Edge Financial Daily on April 5, 2018

VS Industry Bhd
(April 4, RM1.97)
Upgrade to outperform with a lower target price (TP) of RM2.77: We had a recent meeting with management, and remain affirmed of VS Industry Bhd’s merits and long-term growth prospects despite its share price having taken a beating in recent weeks. While we lower our financial year 2018 (FY18) to FY20 earnings estimates between 8% and 15% to account largely for higher cost assumptions, the bulk of which are coming in FY18, we nonetheless upgrade our call from “trading buy” to “outperform” as the current price weakness has made its investment case compelling again. Our TP is lowered to RM2.77 (RM2.99 previously), still based on an 18 times multiple but to a lowered fully diluted FY19 earnings per share of 15.4 sen. We see the higher multiple still justifiable, underpinned by a two-year compound annual growth rate (CAGR) growth nearing 30%.

Much of the fanfare in recent weeks has been on reports of one key customer reportedly ceasing the development of an existing product in preference of a more technologically advanced version. While this is undeniably negative in the mid to longer term (total revenue loss of about RM300 million is expected), actual production will only be phased out in stages, depending on product demand. In any case, we believe new orders of other product lines will likely come in to mitigate the impact. In fact, VS Industry is currently in the running for a number of additional lines (at least one to two) to house in its newly acquired factory which will come on stream in mid-2018. Another customer, meanwhile, has had two end-of-life models ceasing earlier than expected, with replacements also coming in later than expected (typically in March or April, but will now hit the lines only in May and August), hence it is a dampener on FY18 contributions as well. Coupled with weakening of the US dollar against the ringgit, absorption of foreign labour levies and non-optimal operating efficiencies, our FY18 to FY20 earnings estimates are lowered by between 8% and 15%, the bulk of which are coming in FY18. On a positive note, VS Industry stands ready to take on more orders, with recent capacity expansion able to house at least 20 new lines.

VS Industry has received replenishment orders from existing customers, while also securing new ones encompassing healthcare products, air-conditioner components and World Cup souvenir cups. Contributions for the year are anticipated to be flat to mildly positive vis-à-vis FY17. Management anticipates a similar quarterly cycle to that of FY17 in which the second quarter is traditionally the strongest, suggesting only a small profit for the second half of FY18.

Skreen Fabric (M) Sdn Bhd is now a wholly-owned subsidiary, with the remaining 40% bought last month, and has moved its production to a new facility under a RM30 million makeover (with new machinery and technologies), and is now capable of producing six million pieces per annum in a single shift (technically able to do 12 million per year). More importantly, it recently received approval from one of VS Industry’s key customers to commence supply to its product lines, a timely lift for margins going forward. — PublicInvest Research, April 4