This article first appeared in The Edge Financial Daily on January 24, 2019

VS Industry Bhd
(Jan 23, 78.5 sen)
Upgrade to buy with a lower target price (TP) of RM1.02: We attended VS Industry Bhd’s briefing and came back feeling neutral on the group’s outlook. We reckon that the stock renders limited downside risk at this junction as the share price has factored in the negatives, for example, the declining orders from one of its key customers for the Malaysian operations  which will adversely impact the group’s second half of financial year 2019 (2HFY19) earnings while potential order wins could lift sentiment towards the stock.

We believe the group could bag some orders and make the necessary announcement by FY19, given its commanding position in electronics manufacturing services (EMS), being Malaysia’s largest home-grown EMS provider and ranked among the top five EMS providers in the Asean region. Earlier, the group highlighted that total bidding orders are close to RM2 billion. Currently, VS Industry is in the midst of serious discussions with a few multinational corporations (MNCs) to secure new contracts.

We understand that the ongoing US-China trade war renders some opportunities to the group as VS Industry has received many enquiries on new orders from MNCs intending to shift their manufacturing base permanently to Asean from China. Having said that, consumer demand for home appliances or consumer electrical products remains weak in the US and Europe.  

VS Industry is ready to take on any new business with its two additional factories. The group would dedicate the new facilities to cater for new customers with sizeable orders. Should the group secure any new product or model, it can only be put into production or in optimal capacity after one year with requirements of testing, customising its plants and facilities, and other necessary set-up arrangements. Hence, we only expect VS Industry’s earnings to bounce back strongly in FY20 forecast (FY20F)/FY21F.

To recap, operations in China recorded a lower bottom line in the first quarter (1QFY19) as a result of lower orders, rising operating costs and retrenchment costs incurred.

Moving forward, we envisage the group’s China operations will continue posting losses in the coming quarters for FY19F due to weak demand (especially for air purifiers), intense competition, rising costs pursuant to ongoing streamlining exercises and further aggravated by the prevailing US-China trade war.

However, management guided that operational loss will be narrowed in 2QFY19F as compared to 1QFY19.  

Despite the group’s Indonesian operations incurring losses in 1QFY19 due to lower orders and weakening of the rupiah against the US dollar, management is still confident that Indonesia will remain profitable in FY19F. VS Industry foresees higher sales going forward, underpinned by numerous business enquiries as potential customers’ manufacturing base have been shifted to Indonesia from China.

We slash our net profit forecast for FY19 and FY20F by a respective 22.2% and 25% to RM136.6 million and RM154 million. This is to account for the lower sales orders for printed circuit board assemblies and battery packs from its major client in Malaysia, the orders for the new model of coffee-brewing machines, as well as the China operation. Also, we revise downwards our margin assumption in view of elevated labour cost and lower utilisation rate as the group fails to attain optimal capacity and operational efficiency.

Upgrade to “buy” from “hold” with a lower TP of RM1.02 (RM1.31 previously) following our earnings downgrade. Our valuation for the stock is pegged at unchanged price-earnings multiple of 13.5 times of FY19F earnings per share. We advise investors to accumulate on weakness as the group’s long-term fundamental remains intact with its sturdy balance sheet (0.2 times net gearing), experienced management in dealing with difficult times and a good track record. —  JF Apex Securities, Jan 23