This article first appeared in The Edge Malaysia Weekly on May 1, 2017 - May 7, 2017

VS Industry Bhd has always been coy about its major client, and the top-shelf vacuum cleaners that it manufactures for it.

But where non-disclosure agreements keep VS Industry mum, the group’s quarterly income statements have been doing the talking.

Over the past four years, VS Industry’s revenue has expanded by over 40%.  Net profit would have more than doubled, but was held back in the past few quarters due to high start-up costs that the group has incurred for new production lines to ramp up capacity.

In fact, the build-up in production capacity has set tongues wagging. But it is not only about vacuum cleaners this time. The market is abuzz that VS Industry is in the final stages of producing a completely new product for its biggest client.

Checks reveal that VS Industry will be producing a high-end personal care appliance.

“We are in discussions for a new line of products for one of our major clients. We are already preparing two more production lines that will begin operations in October,” managing director Datuk Gan Sem Yam tells The Edge.

While Gan is tight-lipped on the specifics, it is understood that this personal care appliance is already on the market and has seen a positive reception. As more features are added to the product, market expectations are bullish about the appliance’s coming iterations.

As it stands, VS Industry is among the top performing big-cap stocks — up 44.6% year on year to close at RM2 last Friday. At this price, the company is valued at 16.3 times forward earnings.

“For FY2018 [ending July 31], we believe the volume of the new product may hit one million units with further ramp-up in production thereafter depending on the sales performance,” Gan says.

Once production is in full swing, the new product will be a healthy boost to the group’s bottom line, he adds.

External estimates of the new product expect it to lift the bottom line by 10% to 15%, riding on strong margins.

But this is only the short-term upside. Manufacturer-assemblers like VS Industry typically need three-to-four-year commitments from clients to make heavy investments in new production lines.

Based on similar contracts awarded to competitors, it is estimated that a four-year contract of this nature could be worth RM2 billion.

If VS Industry is able to deliver on client ­expectations for the new product, it will cement its role in the supply chain. Key to this is its capability as a fully vertically integrated manufacturer-assembler. Other than specialised components like battery cells and electric motors, VS Industry is able to manufacture the bulk of the components in-house. This ranges from printed circuit boards to plastic injection moulding.

Against this backdrop, recall that VS Industry is also expecting higher volumes from its current core product — vacuum cleaners. It has been well reported that the group expects to complete another two production lines later this year, taking production capacity up to three million units a year.

By next year, with all lines in place, VS Industry will be able to produce as many as four million units.

“We can ramp up capacity for bigger orders; it just depends on the orders from our client,” Gan says.

VS Industry is also expecting bigger orders for its other products. The group is expected to produce at least 2.7 million Keurig coffee machines this year, possibly three million depending on demand.

At the same time, contribution from its ­robotic pool cleaning product client, US-based Zodiac, is projected to expand by about 10% to 15% this year.

It is not surprising therefore that analysts have been relatively bullish on the stock with seven “buy” calls, with target prices ranging from RM2.05 to RM2.35 a share.

VS Industry’s rapid expansion, however, is not without its challenges.

Despite producing top-shelf products for world-renowned clients, many of VS Industry’s processes rely heavily on labour. Today, the company boasts a 6,400-strong workforce in Malaysia, of which over 4,000 are foreign workers.

Many work for the minimum wage, making the company vulnerable to both labour supply shortages and hikes in the minimum wage.

To be fair, the company is exploring avenues to reduce its reliance on labour, but “automation is a big challenge for us. Unfortunately, many of our processes are difficult to automate”, Gan says.

“Right now, it is still quicker to adapt a production line for new products by using workers. Automation can slow down the process of putting new designs on a production line. One of our key products also involves many odd-shaped parts that are difficult to assemble with automation,” he adds.

“We can’t just automate for the sake of it. There must be a tangible return on investment. However, once the production lines run smoothly, we can study what processes to automate if possible.”

Nonetheless, he hopes to trim the company’s headcount by as much as 20% in the coming years via automation.

Looking ahead, the company is expected to maintain its current dividend policy — a minimum payout of 40%. For FY2016 ended July 31, the group paid 4.7 sen per share. Based on this payout, the group has a relatively low yield of 2.4%.

The good news is that the company is relatively self-sufficient in terms of capital, with no cash calls expected in the near future.

“I have been approached by funds looking for a share placement. But at this juncture, we have enough funds. There are no plans to place out shares,” Gan says.

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