27 December 2016 1QFY17 Results Review and Visit Note V. S. Industry Berhad Non-rated Preparing for higher growth in 2HFY17 Fair Value (FV): RM1.42 INVESTMENT HIGHLIGHTS 1QFY17 results within expectations Cost escalated due to start up and labour expenses Brighter 2HFY17 as production shifts to high gear China unit expected to be profitable in FY17 Non rated with FV of RM1.42 pegged at 11x FY17F EPS RETURN STATS Price (23 Dec 2016) Fair Value Expected Share Price Return RM1.38 RM1.42 +2.9% 1QFY17 results within expectations as earnings made up 22% of our full year expectations while revenue makes up 25% of our full year forecast. V.S. Industry s (VSI) profit for the quarter came in at RM33.5m, which is 44% lower yoy but 206% higher qoq. To put things into perspective, its net profit margin for the quarter has been compressed to 4.9% from 9.8% a year ago due to higher start-up cost and a RM0.4m loss in foreign exchange as compared to a gain of RM14.6m in the preceding corresponding period. Cost escalated due to start up and labour expenses. The higher costs incurred during this quarter is attributed to the preparation for more box build jobs from its UK-based Customer D in the coming quarters. The company hired 1000 foreign workers for this reason. As a result, it incurred expenses on new hires, agency fees, foreign employee levies and training costs. We expect cost as a percentage of sales to normalise once this new batch of workers are deployed as production ramps up. Brighter 2HFY17 as production shifts to high gear. The new lines are expected to be able to make 250,000 units per month at its optimal production level. Currently, only one production line for the box build job is running. Management guided that production of this contract will ramp up in 2HFY17. We expect VSI s net profit margin to improve in tandem with the production efficiency, utilisation rate and scale. That said, we are keeping our estimates until operations for the box build contract stabilise. Non rated with FV of RM1.42 pegged at 11x FY17F EPS. We maintain our FY17F EPS forecast of 12.93 sen. Earnings in the second half is likely to come in much stronger as the efficiency for the new box build contract improves. That provides upside potential to our estimates. However, we are keeping our current forecast until its costs normalise. Expected Dividend Yield +3.8% Expected Total Return +6.7% STOCK INFO KLCI 1,617.15 Bursa / Bloomberg Board / Sector Syariah Compliant 6963/ VSI MK Main/ Industrial products Yes Issued shares (m) 1,171.50 Par Value (RM) 0.20 Market cap. (RM m) 1,616.67 Price over NA 1.83 52-wk price Range RM1.13-RM1.69 Beta (against KLCI) 0.65x 3-mth Avg Daily Vol 3.49m 3-mth Avg Daily Value Major Shareholders (%) Datuk Beh Kim Ling and family Datuk Gan Sem Yam and family RM4.91m 20.6% 7.0% is a unit of MIDF AMANAH INVESTMENT BANK Kindly refer to the last page of this publication for important disclosures
2 China unit expected to be profitable in FY17. Although the China unit made a pre-tax loss of RM5m in the quarter under review, it is expected to return to the black due to higher sales volume as well as improving margins, as a result of higher proportion of high-margin products due to VSIG s ODM capabilities. The pre-tax loss during the quarter is due to higher raw material costs that resulted from yuan s depreciation against USD as well as lower sales. Going forward, we expect sales volume to pick up and margins to improve as production for a new air purifier enters a more mature cycle. China operations are essential to VSI as the unit contributed ~20% to the group s topline. Seeing the production in Zhuhai live. Recently, we visited VSI s Zhuhai, China plant with four other sell side analysts in a trip organised by VSI. The whole facility sits on a 78-acre parcel with built up area of 1.5m sq ft and has a lease until 2051. We had the privilege to see the production of a new ODM air purifier for Perfect China. VSI s 43.7%-owned subsidiary, VS International Group (VSIG), is involved in the designing of the product, manufacturing of the parts, assembling, testing and packaging. Production of the new model started in November and it can produce up to 70,000 units per month at full capacity. The new model was well-received by end-buyers during its soft launch on 11.11 as online orders exceeded 20,000 units in two hours. The warm response is due to the improved functions of the new air purifier. The market for air purifier in China is huge due to household concerns of the air quality especially in major cities of China. Better utilisation rate leads to higher bottomline. The utilisation rate for its Zhuhai plant was ~50% before the production of the new air purifier for Perfect China. At optimal level, the utilisation rate improves to 70%, which will impact VSIG s bottomline positively. VSIG also counts Georgia Pacific and Amway as its major clients. Going forward, it expects Diamond to contribute substantially as the latter makes an inroad into China. Recall that VSI has acquired a 20% stake in NEP Holdings (M) Bhd, the company that owns the Diamond brand, for RM60m. The acquisition came with a profit guarantee of RM40m for FY17. On top of that, VSIG is expected to get contracts from NEP to manufacture some of its products such as water filtration systems and water bars (drinking water heaters that can heat up water in a few seconds). We understand that the parties are still in the process of getting approvals from China authorities to sell water filters in China. Once approved, NEP is estimated to contribute more significantly to VSIG s sales from FY18 onwards. Automation is the way to go. Over time, management has upgraded its machines to incorporate more automated processes. One of the reasons is increasing labour costs in China. We understand that a factory operator can earn up to RMB3000 (~RM1930) per month including overtime wages. On top of that, the company provides other benefits such as subsidised food and accommodation for its blue-collar employees. At the time of visit, the plant has a headcount of ~5000. The number of factory operators its employs fluctuates according to its production needs. Positive on VSIG s long-term outlook. We came back feeling upbeat on VSIG s future prospects as the company is able to meet with the stringent manufacturing requirements set by China s relevant authorities. With its track record and relationships with MNC customers in China, it stands good chances of securing orders. There is also room for expansion in that facility due to its land size and speedy construction pace in China. The 78-acre in Zhuhai is much more sizeable than its Johor landbank of 43.7 acres. The Hong Kong-Zhuhai-Macau bridge that is still under construction could further improve the ease of doing business in Zhuhai due to shorter traveling time upon completion. All these factors bode well for the plant s long-term outlook.
INVESTMENT STATISTICS FYE Jul FY13 FY14 FY15 FY16 FY17F Revenue (RM m) 1,163.91 1,715.08 1,936.89 2,175.63 2,719.00 Pretax Profit (RM m) 49.44 41.99 159.69 141.87 199.84 Net Profit (RM m) 43.91 53.63 132.74 117.93 150.38 EPS (sen) 3.78 4.61 11.41 10.15 12.93 EPS growth 17% 22% 148% -11% 27% PER (x) 36.55 29.92 12.09 13.61 10.67 Net Dividend (sen) 1.0 2.3 4.8 4.7 5.2 Net Dividend yield (%) 0.72 1.67 3.48 3.41 3.77 V.S. INDUSTRY: 1QFY17 RESULTS SUMMARY FYE Jul Source: Company, MIDFR Quarterly Results Cumulative Comments 3QFY16 %YoY %QoQ 9MFY16 %YoY Revenue (RM m) 680.02 11.0% 22.7% 680.02 11.0% More contracts clinched Pretax Profit (RM m) Net Profit (RM m) 45.49-39.2% 413.4% 45.49-39.2% 33.51-44.3% 206.3% 33.51-44.3% EPS (sen) 2.86-45.2% 204.3% 2.86-45.2% Net DPS (sen) 1.20-20.0% 50.0% 1.20-20.0% 40% payout DAILY PRICE CHART Higher initial start-up cost from the Malaysian unit in preparation of the upcoming sizeable box build contract. It also made a foreign exchange loss of RM0.4m compared to a gain of RM14.6m a year ago. Source: Bloomberg Syed Muhammed Kifni Ng Bei Shan ng.bs@midf.com.my 03-2173 8461 3
4 APPENDIX The product undergoes a comprehensive series of tests before being packed and delivered. New warehouse at the Zhuhai facility under construction. Solar panels in the Zhuhai plant powers ~20% of the facility s electricity consumption. A highly-automated plastic injection line that reduces labour drastically. Packed products stored in a warehouse ready to be delivered. One of the product certificates from the China Quality Certification Centre.
5 is part of MIDF Amanah Investment Bank Berhad (23878 - X). (Bank Pelaburan) (A Participating Organisation of Bursa Malaysia Securities Berhad) DISCLOSURES AND DISCLAIMER This report has been prepared by MIDF AMANAH INVESTMENT BANK BERHAD (23878-X). It is for distribution only under such circumstances as may be permitted by applicable law. Readers should be fully aware that this report is for information purposes only. The opinions contained in this report are based on information obtained or derived from sources that we believe are reliable. MIDF AMANAH INVESTMENT BANK BERHAD makes no representation or warranty, expressed or implied, as to the accuracy, completeness or reliability of the information contained therein and it should not be relied upon as such. This report is not, and should not be construed as, an offer to buy or sell any securities or other financial instruments. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. All opinions and estimates are subject to change without notice. The research analysts will initiate, update and cease coverage solely at the discretion of MIDF AMANAH INVESTMENT BANK BERHAD. The directors, employees and representatives of MIDF AMANAH INVESTMENT BANK BERHAD may have interest in any of the securities mentioned and may benefit from the information herein. Members of the MIDF Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein This document may not be reproduced, distributed or published in any form or for any purpose. MIDF AMANAH INVESTMENT BANK : GUIDE TO RECOMMENDATIONS STOCK RECOMMENDATIONS BUY TRADING BUY NEUTRAL SELL TRADING SELL Total return is expected to be >15% over the next 12 months. Stock price is expected to rise by >15% within 3-months after a Trading Buy rating has been assigned due to positive newsflow. Total return is expected to be between -15% and +15% over the next 12 months. Total return is expected to be <-15% over the next 12 months. Stock price is expected to fall by >15% within 3-months after a Trading Sell rating has been assigned due to negative newsflow. SECTOR RECOMMENDATIONS POSITIVE NEUTRAL NEGATIVE The sector is expected to outperform the overall market over the next 12 months. The sector is to perform in line with the overall market over the next 12 months. The sector is expected to underperform the overall market over the next 12 months.