VS Industry Bhd
(Aug 17, RM1.43)
Trading buy with a fair value of RM1.73: Recall that two years ago we discovered this gem, which managed to lock in a total capital gain of 286% (in March 2015).

Since then, VS Industry Bhd has continued to outperform and registered supernormal earnings in financial year 2015 (FY15), backed by stellar revenue performance and favourable currency translations.

For its latest nine months of FY16 results, even with the absence of favourable foreign-exchange gains, net profit still grew by 34%, underpinned by solid revenue growth and a better earnings before interest and tax (Ebit) margin of 9%, on the back of a favourable product mix and higher operational efficiency.

To our positive surprise, VS Industry is already setting up a new assembly line to supply box-build assembly services for Dyson Manufacturing Sdn Bhd’s cordless vacuum cleaners, with mass production to commence by early FY17.

This is on top of ongoing orders for printed circuit board assembly and battery packs.

Note that this new line could produce up to 20,000 units per week in max ramp mode and potentially add up to RM400 million per year to the group’s top line.

More positively, management cited that there are chances for more orders being secured in the near term, which would require the group to set up another two lines should demand swell strongly.

For now, our earnings forecasts only account for the projection of an additional box-build assembly line.

We gather that there were some delays in the delivery of new coffee machines in June 2016 to its US customer due to supply components issues.

However, this has been resolved, with the shipment spilt over to December 2016. Recall that management previously guided that a total shipment of two million would be fulfilled by June 2016.

Moving forward, the group will also be doing another new model for this US customer, which might see its total product shipment rising to three million a year in a blue-sky scenario.

Beyond the above-mentioned, the group has recently proposed to acquire up to a 20% stake in the enlarged issued and paid-up capital of NEP Holdings (M) Bhd, which is principally involved in assembling, wholesaling, distributing and trading of Diamond water filtration systems and healthcare-related products.

The acquisition cost of RM60 million, to be satisfied by cash, implies a forward price-earnings ratio (PER) of 7.5 times, based on a profit guarantee of RM40 million in FY17.

We are positive on the deal given the undemanding forward PER valuation, which is below the industry’s average forward PER; net profit guarantee of RM40 million for FY17 by NEP and high profit after tax margin that NEP carries; and new stream of manufacturing revenue for VS Industry.

We are projecting the group to register FY16 and FY17 net profits of RM122.9 million and RM168.8 million respectively, with key earnings assumptions being a two-year revenue compound annual growth rate of 18% to be anchored by Dyson’s new box-build business, the new coffee brewing machine and the new manufacturing job from NEP as well as an Ebit margin assumption of 7.9% to 8.1%, on the back of a healthy utilisation rate assumption.

We value VS Industry at RM1.73 per share, based on 12 times FY17 PER, a valuation which is at a 15% discount to the valuation we ascribed to SKP Resources Bhd, in view of its smaller quantum of earnings improvement due to a high base. — Kenanga Research, Aug 17