This article first appeared in The Edge Financial Daily, on July 11, 2016.

VS Industry Bhd
(July 8, RM1.18)
Initiate coverage with a target price (TP) of RM1.50: Despite its share price falling 25% year-to-date due to a rebound in the ringgit and selling pressure on export-oriented counters, we believe VS Industry Bhd still commands a resilient business model, which is able to provide fully integrated assembly services for electronic manufacturing services.

VS Industry is a fundamentally sound company, enjoying a five-year compound annual growth rate (CAGR) of 19% for revenue and a CAGR of 40% for headline net profit for the financial year ended July 31, 2010 (FY10) to FY15.

We envisage its core net earnings to grow by 29.9% to RM135.7 million for FY16 forecast (FY16F), and by 20.6% to RM163.7 million for FY17F, with key earnings contributions from its three major clients, namely Dyson, Keurig and Zodiac. 

VS Industry commands a sturdy balance sheet with a currently low net gearing of 0.2 times, which allows it to have ample flexibility to gear up for future capacity expansion and mergers and acquistions.

We believe it could clinch more orders in respect of box build full assembly for the new vacuum cleaner model from Dyson. The first purchase order could come in a few months’ time. It could bag as much as RM300 million new orders per annum from Dyson from FY17F, over a period of three to five years. 

This would lift earnings by 12.6% for FY17F and 10.8% for FY18F. This is on top of existing Dyson models with a job scope worth an estimated RM650 million in FY17F. Our earnings forecasts have yet to factor in potential contract wins.

VS Industry may consider taking up a stake in a healthcare and wellness company to reap synergistic benefits. This could render sub/full assembly works worth RM180 million yearly under its China operation, in addition to profits from the ownership stake in the immediate term. Should the acquisition materialise, it could contribute RM13 million in yearly net profit to the group from FY17F onwards.

For the recent acquisition of a 12.1% stake in Seeing Machines Ltd, we expect VS Industry to benefit from research and development collaboration and manufacturing opportunities of the company in the longer run.

Historically, VS Industry’s net margin of 3% to 5% was significantly below its peers of 6% to 9%, mainly dragged down by losses in overseas operations. We reckon that the group’s profit margin would improve along with the anticipated profit turnaround in its China and Indonesia operations. 

VS Industry’s Indonesian market is expected to be profitable in FY16F (first nine months of FY16 [9MFY16]: profit before tax (PBT) of +RM4.8 million; FY15: PBT of -RM3.6 million), while the China market is envisaged to break even in FY16F (9MFY16: PBT of +RM2.8 million; FY15: PBT of -RM7.6 million).

Thus, the group’s overall core net margin (excluding foreign-exchange gain/loss) could improve to 6.5% to 7% for FY16F to FY18F, from 5.4% in FY15.

It subscribes to a minimum 40% net profit payout as its dividend policy with quarterly dividend declarations. We expect VS Industry to reward shareholders with 4.8 sen/share for FY16F and six sen/share for FY17F, which translate into decent dividend yields of 4% to 5% based on the current closing price. 

The group is currently enjoying an average utilisation rate of below 60%, which allows it to continue growing without incurring heavy capital expenditure.

We estimate the group’s FY16F, FY17F and FY18F core net earnings to trend positively, up 29.9%, 20.6% and 18.1% respectively, on the back of higher revenue (FY16F: +9.1%; FY17F: +11.9%; FY18F: +16.9%). Furthermore, the group’s profit margin is expected to continue expanding in line with the turnaround in overseas operations.

We initiate coverage of VS Industry with a TP of RM1.50, based on 12.5 times FY17F price earnings (PE), with a diluted earnings per share forecast of 12 sen.

The PE ratio assigned for valuation of VS Industry is at the sector’s average PE and +2 standard deviation above the mean of historical PE of the group. 

The target PE is warranted, in view of the group’s capability of securing sizeable orders from Dyson, and its potential strategic acquisition of a healthcare and wellness company under its China operation to further expand its earnings in FY17F. — JF Apex Securities, July 8