EMS€¦ · 14-10-2019 · We initiate coverage on the Electronics Manufacturing Services (EMS) sector with an Overweight call, not merely as a beneficiary from the trade diversion

10 October 2019

Affin Hwang Investment Bank Bhd (14389-U)

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Leveraging on “D” ecosystem

We initiate coverage on the Electronics Manufacturing Services (EMS)

sector with an Overweight call, not merely as a beneficiary from the

trade diversion but also to ride on the rapid expansion of their common

key customer – a global renowned household appliances brand. ATA

IMS (BUY, TP: RM1.80), is our preferred sector pick, as we expect the

group to continue charting strong growth on the back of capacity

expansion coupled with margin enhancement from further vertical

integration. We also initiate coverage on V.S. Industry (BUY, TP: RM1.60)

given the group’s diversified customer mix and strong ability in

securing new contracts, which makes it a prime beneficiary of trade

diversion. Elsewhere, we highlight 3 other companies, namely SKP

Resources (Non-rated, RM1.08), i-Stone (Non-rated, RM0.18) and

MTAG (Non-rated, RM0.42), which form part of the “D” ecosystem.

Riding on the key customer’s innovation & growth prospects

V.S. Industry (VS), ATA IMS (ATA), and SKP Resources (SKP) are the three

largest home-grown EMS players in Malaysia (with a combined market

cap of US$1.3bn), serving a common key customer. We expect the sector

continue to grow on the back of rising demand for the key customer’s

premium household appliances, underpinned by: i) a growing middle class,

ii) improving standards of living in developing countries, and iii) rising

demand for high-tech household appliances. The key customer is able to

enjoy a lower cost of production with its entrenched ecosystem in

Malaysia and will continue its investment in technology which should

benefit the Malaysian supply chain.

Window of opportunity from trade diversion

With the escalating US-China trade tension and rising cost of manufacturing in

China, most of the EMS players have received increased enquiries from

multinational corporations (MNCs) looking to shift or diversify their

manufacturing base away from China, and are in discussion with their

prospective customers for potential new opportunities.

Initiate with Overweight rating

Sector PE valuations have de-rated over the past 2 years due to lowered

growth expectations. Trading below its historical mean PER of 13x on

CY2020E, the sector’s risk-reward is looking favorable in view of the: 1)

growth upside of a major global household appliances brand, of which the

three collectively produce >50% of the key customer’s global production; and

2) positive impact from trade diversion which could positively enhance the

sector’s CY18-21E core net profit CAGR of 12%. Downside risks: i) key

customer risk; ii) reliance on foreign labor, iii) competition risk, iv)

downturn in household appliances industry, and v) economic slowdown.

Peer Comparison

Source: Bloomberg, Affin Hwang forecasts* Note: Based on closing prices on 9 October 2019

EMS Peers Rating Sh Pr TP Upside Mkt Cap ROE (%) DY (%)

(RM) (RM) (%) (RM m) CY19E CY20E CY19E CY20E CY19E CY20E CY19E CY20E CY19E CY20E CY19E FY20E

ATA IMS* BUY 1.45 1.80 24.1 1,746.3 14.3 12.9 14.8 10.6 24.9 8.9 8.7 7.6 2.5 2.2 19.0 2.5

V.S. Industry* BUY 1.26 1.60 27.0 2,314.0 13.8 12.6 8.9 9.5 (2.0) 6.0 7.5 6.4 1.4 1.3 10.8 3.4

SKP Resources N/R 1.08 N/R N/R 1,350.2 12.5 10.5 1.5 20.6 4.0 14.4 6.9 5.7 2.2 2.0 17.3 4.3

P.I.E. Industrial N/R 1.37 N/R N/R 526.1 13.7 11.3 (11.6) 21.2 3.5 9.7 6.2 5.5 1.2 1.1 9.0 3.6

Average 13.6 11.8 3.4 15.5 7.6 9.7 7.3 6.3 1.8 1.7 14.0 3.5

Peers within "D" Ecosystem CY17A CY18A CY17A CY18A CY17A CY18A CY17A CY18A CY17A CY18A CY18A CY18A

i-Stone Group N/R 0.18 N/R N/R 226.0 18.5 15.3 107.1 17.6 40.0 11.9 22.2 17.4 n/a 3.7 19.1 n/a

MTAG Group N/R 0.42 N/R N/R 286.3 10.0 8.5 48.3 18.1 19.3 0.9 5.8 4.9 n/a 1.8 20.2 n/a

Average 14.2 11.9 77.7 17.9 29.6 6.4 14.0 11.2 n/a 2.7 19.7 n/a

Core P/E (x) Core EPS Growth (%) Rev. Growth (%) EV/EBITDA (x) P/B (x)

Sector Initiation

EMS

Overweight (Initiation)

Absolute Performance (%)

1M 3M 12M ATA 7.4 -9.9 -14.7 VS -2.3 8.6 -24.6 SKP 1.9 -15.0 -15.0 PIE 24.5 0.0 -14.2 ISTONE 8.8 n/a n/a MTAG n/a n/a n/a

Relative Performance to KLCI (%)

Source: Bloomberg, Affin Hwang

Stock Summary

Name Rating Mkt cap

Price TP

(RM) (RM) (RM)

EMS Peers ATA IMS* BUY 1,746 1.45 1.80 V.S. Industry* BUY 2,314 1.26 1.60 SKP Resources N/R 1,350 1.08 N/R P.I.E. Industrial N/R 526 1.37 N/R Peers within “D” Ecosystem i-Stone Group N/R 226 0.18 N/R MTAG Group N/R 286 0.42 N/R

Source: Bloomberg, Affin Hwang forecast* Note: Based on closing prices on 9 October 2019

Chua Yi Jing (603) 2146 7546

[email protected]

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10 October 2019


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Table of Contents Sector Initiation

EMS industry growth prospects The three largest listed EMS players in Malaysia

Rising demand for household appliances


Key customer’s shifting of headquarters

Introducing “D” ecosystem in Malaysia

Valuation and recommendation

Key investment risks

Company Section

ATA IMS Bhd (Initiation)

Investment Thesis Financial Analysis and Forecasts


Company background

V.S. Industry Bhd (Initiation)

Investment Thesis Financial Analysis and Forecasts


Company background

SKP Resources Bhd (Non-rated)

i-Stone Group Bhd (Non-rated)

MTAG Group Bhd (Non-rated)

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EMS industry growth prospects

EMS industry – backbone of every prominent brand

The Electronics Manufacturing Services (EMS) industry has played an integral role in the development and growth of manufacturing industries worldwide. EMS companies function as strategic partners to original equipment manufacturers (OEMs) or brand owners by providing a full range of services which include contract design, testing, manufacturing, final assembly, order fulfillment, and repair and aftermarket services.

Rising trend towards outsourcing – a boon to EMS

The rising trend and growing preference towards outsourcing production

has enabled OEMs and brand owners to focus on their core competencies

(such as R&D, brand building, and sales and marketing), and to maintain

their competitive advantage in the face of rapidly changing market

conditions, global competition and technological advances. By using the

services of EMS providers, OEMs and brand owners can gain access to

the latest design and engineering capabilities, process knowledge and

manufacturing know-how without having to make substantial capital

investments. Outsourcing to EMS providers also helps OEMs and brand

owners to reduce costs by turning fixed costs into variable costs.

A win-win solution for brand owners and EMS providers

Case in point, Zodiac Pool Solution, a leading supplier of automatic pool

cleaners and pool products, shut down its plants in France and Australia in

2014 and 2015 respectively after outsourcing orders to V.S. Industry and

being satisfied with the latter’s competitive pricing and quality, where

market rejections rate are much lower. Currently, VS is the sole

manufacturer of Zodiac’s robotic pool cleaner in the world and has started

producing other pool cleaning-related products such as chlorinators. This

strategy has proven to be beneficial to OEMs and brand owners, and has

helped the EMS market size to expand at a rapid pace in recent years.

To grow at a 7-year CAGR of 8.1% over 2018-2025

As global outsourcing continues to gather momentum, EMS providers are

set to witness a substantial increase in business opportunities in times to

come. According to Adroit Market Research, the EMS market is expected

to grow at a CAGR of 8.1% during the 2018-2025 period and reach

US$847.1bn by 2025 (Fig 1).

Fig 1: Global EMS market size to grow at a 7-year CAGR of 8.1%

Source: Adroit Market Research, Affin Hwang

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The three largest listed EMS players in Malaysia

The three largest homegrown EMS players in Malaysia

V.S. Industry (VS), ATA IMS (ATA) and SKP Resources (SKP) are the

three largest home-grown EMS players in Malaysia listed on the Main

Market of Bursa Malaysia. They are also the three closest peers in their

industry. Among the three, VS and ATA are two of the top 30 largest EMS

providers in the world (by revenue size), based on the Manufacturing

Market Insider’s (MMI) 2018 list. VS and ATA were ranked 23rd and 30th

respectively in 2018, competing against the likes of Taiwan’s industry

giants Foxconn and Pegatron.

Fig 2: Excerpt of the MMI Top 50 EMS Providers in 2018

Source: Manufacturing Market Insider (MMI), Affin Hwang

Serving a common customer – a prominent global brand

The trio are based in Johor, serving a common key customer within the “D”

manufacturing ecosystem. Their single largest key customer, a global

renowned household appliance brand (the actual name cannot be

disclosed due to the companies’ commercial arrangement with the key

customer), is best known for its floor-care products and other household

appliances. It is reported that the key customer is among the world's top 4

floor-care brands by units sold. With sales of its products in over 80

countries and regions, this customer has registered strong financial

performance since 2010 with an 8-year revenue CAGR of 22%, bolstered

by growing demand for its high-tech household appliances.

The MMI Top EMS Providers in 2018 Region of origin

1 Hon Hai Precision Industry (Foxconn) New Taipei, Taiw an

2 Pegatron Taipei, Taiw an

3 Flex Singapore

4 Jabil St. Petersburg, FL

5 Sanmina San Jose, CA

6 Wistron Taoyuan, Taiw an

7 Celestica Toronto, Canada

8 New Kinpo Group New Taipei, Taiw an

9 Universal Scientif ic Industrial Co Shanghai, China

10 Plexus Neenah, WI

11 Venture Singapore

12 Benchmark Electronics Angleton, TX

13 Shenzhen Kaifa Shenzhen, China

14 Zollner Elektronik Group Zandt, Germany

15 SIIX Osaka, Japan

16 Fabrinet Pathumthani, Thailand

17 Integrated Micro-Electronics, Inc Laguna, Philippines

18 UMC Electronics Saitama, Japan

19 Kimball Electronics Group Jasper, IN

20 Sumitronics Tokyo, Japan

21 Asteelf lash Neuilly Plaisance, France

22 Ultra Electronics Greenford, UK

23 V.S. Industry Berhad Senai, Malaysia

24 Pan International Taipei, Taiw an

25 Kaga International Fremont, CA

26 Neo Tech Chatsw orth, CA

27 VTech Communications Hong Kong

28 Videoton Holding Székesfehérvár, Hungary

29 Scanfil EMS Sievi, Finland

30 ATA IMS Berhad Johor Bahru, Malaysia

10 October 2019


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Focus on vertical integration and more automation

The EMS players have actively been in expansionary mode, pursuing

further vertical integration and more automation to improve efficiency,

profitability and success rates. ATA and SKP have both started printed

circuit board (PCB) assembly and battery pack assembly divisions

following indications of demand by their key customer. In addition, ATA is

looking to add another 2 capabilities in-house, namely wire harness and

brush bar assembly, which it currently purchases from third-party suppliers.

Low margin due to nature of business…

The trio typically record low to mid-single digit core net profit margins, with

SKP leading the pack, followed by VS and ATA. The discrepancy in

profitability is mainly due to their customer mix. Based on our estimates,

ATA derives over 80% from its key customer and hence derives a lower

margin as compared to SKP and VS, which have a lesser reliance on their

key customer (SKP: over 70%, VS: over 50%) (Fig 3). While VS has the

least reliance on the key customer, its net margin is lower than SKP’s as

profitability is impacted by its China operations. VS’ Malaysia operation’s

pre-tax profit is higher than SKP’s.

… but still higher than most of the regional peers

While the net margin for the trio of 4-6% may appear low, it nevertheless is

still ahead of their regional low-mix/high-volume (LMHV) peers of 1-2%.

The margin for high-mix/low-volume (HMLV) peers such as Venture Corp

and Fabrinet are not comparable to LMHV’s as HMLV contract

manufacturers typically focus more on customization with high

customer/product mix and low volume, hence typically command higher

margin as compared to LMHV (Fig 3).

Fig 3: Local vs. regional & LMHV vs. HMLV peers – core net margin trend

Source: Bloomberg, Affin Hwang forecasts*

LMHV: Local Peers CY18A CY19E CY20E

ATA IMS* 3.9% 3.6% 3.7%

VS Industry* 3.8% 4.2% 4.4%

SKP Resources 5.9% 5.6% 5.9%

Average 4.6% 4.5% 4.6%

LMHV: Regional Peers CY18A CY19E CY20E

Flex Ltd 2.3% 2.4% 2.7%

Celestica Inc 2.3% 1.2% 1.8%

Jabil Inc 2.0% 1.9% 2.1%

Hon Hai Precision Industry (Foxconn) 2.4% 2.1% 2.1%

Quanta Computer Inc 1.5% 1.5% 1.5%

Inventec Corp 1.3% 1.3% 1.4%

Compal Electronics 0.9% 0.8% 0.8%

Wistron Corp 0.6% 0.6% 0.7%

Average 1.6% 1.5% 1.6%

HMLV: Regional Peers CY18A CY19E CY20E

Venture Corp Ltd 10.6% 10.1% 10.2%

Fabrinet 8.8% 8.6% 8.9%

Plexus Corp 3.8% 3.3% 3.5%

Average 7.7% 7.3% 7.5%

High-mix / low-volume (HMLV)

Low-mix / high-volume (LMHV)

10 October 2019


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Rising demand for household appliances

Competitive advantages of the key customer

The key customer enjoys superior profitability of above 20% as compared

to many of its peers, thanks to its innovative and high-end products.

Trusted Review, one of the largest reviews websites in the UK that focuses

on technology product review, tested all battery-powered floor care

products through a rigorous set of tests, and the key customer’s floor care

products are ranked the top best-scoring cordless floor-care products and

is the only brand to achieve a 10/10 score. In spite of the success, the key

customer is not resting on its laurels and the founder of the MNC was

quoted in Forbes that the company aims to develop 100 new products by

2020. Currently it has lesser than 60 products listed on its UK website. We

believe this will continue to bring strong order flow for the three EMS

companies.

Fig 4: The key customer’s net profit and net margin track record

Source: Various, Affin Hwang

Growing demand for household appliances to support the growth

We expect demand for premium household appliances to continue to grow,

underpinned by:

Growing middle class. The key customer’s products continue to

garner massive appeal among Asia’s rising middle class, who are able

to afford big-ticket purchases and willing to invest in high-tech and

lifestyle-enhancing products. According to research from the

Brookings Institution, a non-profit public policy organization based in

Washington, September 2018 marked a global tipping point as just

over 50% of the world’s population (or some 3.8bn people) live in

households with enough discretionary expenditure to be considered

“middle class” or “rich.” The middle class is projected to grow at a

CAGR of 3% to reach 5.3bn people worldwide by 2030, which is

c.62% of the 8.6bn world population estimated by United Nations.

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Fig 5: Growing global middle class

Notes: Income categories, using PPP-adjusted (2011) dollars, are: extreme poor <$1.90/day; vulnerable = $1.90 to $11/day; middle class = $11 to $110/day; rich >$110/day. Source: The Brookings Institution

Improved standards of living in developing countries. Not only are

the key customer’s products within the top-selling household

appliances in many developed markets, it also grabbed the hearts of

the middle classes in emerging markets. In 2018, the key customer

reported record earnings of GBP1.1bn (RM5.7bn), mainly due to high

demand from Asian consumers where it derives more than half of its

profit. In addition, of the abovementioned growing global middle class,

the bulk of the growth will come from Asia. By 2030, Asia will

represent 66% of the global middle-class population and 59% of

middle-class consumption, compared to 28% and 23% respectively in

2009, according Organisation for Economic Co-operation and

Development (OECD).

China, one of the fast-growing countries targeted by the key

customer. The key customer is focusing on the fast-growing

Southeast Asia markets, especially China. Notably, Alibaba said that

some of its top-selling products during its annual Singles’ Day event in

2018 came from this key customer. According to Statista, the revenue

in the consumer electronics segment in China would amount to

US$127.3bn in 2019 and is expected to grow at a 5-year CAGR of

9.5%, resulting in a market volume of US$180.0bn by 2023 (Fig 6).

10 October 2019


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Fig 6: Revenue in the consumer electronics segment in China

Source: Statista, Affin Hwang

Growing demand for high-tech household appliances. According

to Allied Market Research, the global household floor-care market is

expected to grow at a CAGR of 4.7% during the 2015-2022 period and

reach US$16.7bn by 2022. The global household appliances market,

on the other hand, is projected to grow at a CAGR of 5.4% during the

2018-2025 period and reach US$763.5bn by 2025. With the

technological advancements, there is a great thirst for new technology

and well-designed household appliances. It is reported that the key

customer's share of the non-robot floor care market is increasing. It hit

6.1% in 2016, up from 5.4% in 2014, despite its high prices that are in

the range of RM1,500-3,000 (US$300-600) (Fig 7). This is mainly

driven by the key customer’s willingness to invest in technology and

focus on developing products that solve problems for the public. The

key customer has affirmed that technology continues to be at the

forefront of its business, with the company continuing with a

GBP2.5bn (US$3.0bn) investment program in technology.

Fig 7: Price comparison between the key customer & its peers (in US$)

*Unable to disclose actual name due to the companies’ commercial arrangement with the key customer Source: Nikkei Asian Review, Affin Hwang

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Potential beneficiary of US-China trade diversion

Other than riding on the growth prospects of its key customer, the US-

China trade tension has also opened up a window of opportunity for the

three Malaysia’s EMS players. With the escalating US-China trade tension

and the rising cost of manufacturing in China, MNCs and Chinese

companies are mulling to relocate their manufacturing base from China to

Southeast Asia countries. As the 7th-largest electrical & electronic (E&E)

exporter in the world, Malaysia is one of the preferred destinations, to avoid

US tariffs of as much as 25% on some US$250bn of imports from China.

US imports from China have fallen 13%, while exports to China have

declined 16% in the first eight months of 2019, a reflection of dwindling

two-way trade (Fig 8).

Fig 8: The yoy growth of the US trade in goods with China

Source: The United States Census Bureau, Affin Hwang

Malaysia’s FDI momentum picked up since 2018

According to a survey by the American Malaysian Chamber of Commerce

(Amcham) on American E&E companies based in Malaysia, 76% of the

companies intend to invest further in the country over the next 5 years. The

survey also found that there were 12 new product lines and 6 research &

development (R&D) centres and centres of excellence relocated to

Malaysia within the past year. In addition, based on the official data from

the Malaysia Investment Development Authority (MIDA), Malaysia’s

approved foreign direct investment (FDI) surged 48% to RM80.5bn in 2018

(Fig 9). Even stripping off the one-off factor of the acquisition of a 16%-

stake in IHH Healthcare by Japan’s Mitui & Co. Ltd., the approved FDI in

2018 was still a positive yoy growth of 32%. The 2018 approved FDI was

an all-time-high, even as global FDI figures dipped to the lowest levels in a

decade. In 6M19, the country’s approved FDI continued to grow by a

whopping 97% yoy to RM49.5bn. The increased in FDI is a possible sign

of a business diversion from the MNCs, in our view, as trade tensions

continue to escalate.

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Fig 9: Malaysia’s approved FDI

Source: MIDA, Affin Hwang

MNCs knocking at the doors of EMS players

We gather that most of the EMS players have received enquiries from

MNCs looking to shift or diversify their manufacturing base from China and

most of the EMS players have jumped on the bandwagon to explore new

opportunities stemming from the escalating US-China trade standoff. While

little has materialized at this juncture and may require some time for the

actual investment and shift in manufacturing to happen, as moving a

manufacturing base is not an easy task as it requires the MNCs to

rearrange their entire supply chain, there are ongoing discussions and the

MNCs are already doing a lot of planning on how to do this.

One in the bag and the rest are also in serious discussions

So far, VS has secured a new customer, Bissell, as a result of the trade

tension, and the group is in the midst of discussions with other prospective

customers. Meanwhile, ATA is also in discussions with its prospective

customers for potential new contracts, with preference towards Internet of

Things (IoT) related opportunities. Both players are positive on their

potential to secure new orders and/or customers given their proven strong

track records. In addition, we gather that the Penang-based EMS players,

namely PIE Industrial (Non-rated, RM1.37) and CPI, the newly acquired

wholly-owned subsidiary of Kumpulan Perangsang Selangor (Non-rated,

RM0.65), have secured new orders from a number of new customers given

the customers’ shift in supply chain motivated by the trade tension.

Key customer’s shifting of headquarters

A boon to the Johor-based EMS players

The key customer has announced early this year that it will move its

corporate head office to Singapore as it believes that its center of gravity

now lies in Asia, where it sees tremendous opportunities for growth.

Meanwhile, it also announced investment plans including i) the expansion

of its Singapore Technology Centre to double its current size, and ii) its

Malaysia Design Centre’s (MDC) fifth phase of development. It will also

build its new electric vehicle (EV) in its new factory there. We think the key

customer’s shift of regional headquarters to Singapore, which is a stone’s

throw away from its global manufacturing hub in Johor, should be positive

to the Johor-based EMS players.

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Opportunity from key customer’s new venture minimal at the moment

The key customer has been working on an EV for several years and aims

to launch its first EV by 2021. While the three EMS players stand a high

chance in clinching any potential automotive-related contract from the key

customer as they have been serving customers in the automotive industry

and supplying plastic parts that are used in automotive, we understand that

the initial EV-related contract, if any, is likely to be small in term of

production volume, as compared to the key customers’ existing household

appliances.

Introducing “D” ecosystem in Malaysia

“D” ecosystem in Malaysia fulfills >50% of its requirement globally

Recently 2 non-EMS-related companies which are part of “D” ecosystem

were newly listed on Bursa Malaysia, namely i-Stone Group (Non-rated,

RM0.18) and MTAG Group (Non-rated, RM0.42). In total, there are now 5

Johor-based listed companies in Malaysia that form part of the “D”

ecosystem, serving this common key customer. These 5 companies are

involved in the: i) box-build assembly & sub-assembly, ii) PCB and battery

pack assembly, iii) manufacturing of filters, iv) customized specialized

automation machines, and v) label printing and material converting in the

key customer’s supply chain. Notably, they fulfill more than half of the key

customer’s requirement globally in their respective segments, playing an

important role in supporting the growth of the key customer.

A strong ecosystem to support “D” growth

With a well-established strong ecosystem in Malaysia, the key customer is

able to enjoy a lower cost of production altogether and become more

competitive, in our view. In the long run, the continuous investment of the

key customer should continue to benefit Malaysian companies that are in

its supply chain. This can also be seen from the rapid expansion plans by

the five companies, with most of the EMS players (ATA and VS) having

recently completed theirs, SKP’s in the process, while the newly-listed i-

Stone and MTAG to follow with their newly-raised funds from IPOs.

Fig 10: The companies in “D” ecosystem in Malaysia are less than 100km

away from the key customer’s Technology Centre in Singapore

Source: Affin Hwang

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Elimination of Malaysian supply chain unlikely, in our view

While the key customer’s appointment of another Taiwanese company for

contract manufacturing in the Philippines has sparked investors’ concern

over a potential shift of supply chain to the Philippines, we understand that

the intention of the appointment is largely to tap on the benefit of zero

export tariff from the Philippines to the US. Coupled with the key

customer’s recent shifting of headquarters to Singapore with its view that

its center of gravity lies in Asia, where it sees tremendous opportunities for

growth, we think it is unlikely that the key customer will move its entire

supply chain to another country. In our view, with the key customer’s

ambitious plans and aggressive R&D roadmap, we think that the future

business is large enough to support both a Malaysian and Philippines

supply chain.

Any other non-EMS options to tap on “D” growth?

As part of the ecosystem, i-Stone supplies various specialized automation

machines to the key customer, while MTAG supplies certain components

of household appliances such as mesh, labels and stickers, tapes and

adhesives to the key customer. The key customer is their single largest

customer, making up 65% and 80% of i-Stone and MTAG’s revenue

respectively. Both of the companies have similar ranges of core net profit

margins, which stand at an average of 15% over the past four years.

Notably, their margins have improved over the past four years on the back

of greater cost efficiency and economies of scale; for the latest financial

year core net profit margin stands at 17%. Investors who are interested in

tapping on “D” growth but concerned about the low margin of EMS players

now have more options with the two newly-listed companies, details of

which are discussed in pages 49-52 of this report.

Barrier of entry to “D” ecosystem

As part of the key customer’s quality control and costing process, its

suppliers and contract manufacturers need to undergo stringent

qualification before becoming approved suppliers and contract

manufacturers to the key customer. Given the costly and time-consuming

qualification process, it is believed that the approved suppliers and

contract manufacturers are able to maintain their business relationships

with the key customer, as it will not be easy and commercially viable for

them to seek alternative suppliers. Based on our channel checks, today it

would take at least RM500m to set up a manufacturing facility for the key

customer – with no guarantee of business. We think this alone is a great

barrier to entry for existing players.

Established working relationship of >10 years with the key customer

The 5 companies have been working with the key customer for >10 years,

proving their capabilities in meeting the key customer’s high standards of

quality. All five companies have recorded robust average 3-year revenue

and core net profit CAGRs of close to 20% on the back of the key

customer’s strong revenue and net profit growth of 36% and 33%

respectively (Fig 11).

10 October 2019


Page 13 of 54

Fig 11: 3-year revenue and core net profit CAGR of the five companies that

are part of “D” supply chain

Source: Various, Companies, Affin Hwang


Initiate EMS sector with Overweight rating

We initiate coverage on the EMS sector with an Overweight rating as we

expect the sector to record a strong 3-year sector core net profit CAGR of

12% (CY18-21E) by riding on the brand owner’s growth prospects and

tapping on the opportunities arising from US-China trade standoff. The

sector currently trades at an attractive valuation of only 12x CY2020E. The

downside risk is minimal, in our view, as share prices of the EMS players

have weakened by >20% from their recent highs. We believe there is re-

rating potential for the EMS players’ PER multiple and it is time to revisit

the sector and appreciate its strong growth prospects given the key

customer’s strong product pipeline. While a protracted US-China trade

standoff would undeniably hurt most of the businesses in the world, we

think that the three EMS companies could be better off as beneficiaries of

the trade tension.

Premium valuation against regional peer justifiable by strong growth

While the local EMS sector has been trading at around 3-4x PER above

the regional EMS’ (Fig 15), we think it is well justified by the strong growth

demonstrated by the local EMS players. In terms of revenue, the local

EMS sector has charted an astounding 10-year CAGR of 59%, which was

almost quadruple of the regional peers’ 15% over the same period. The

10-year net profit CAGR of the local EMS sector was even higher at 63%

as compared to regional peers’ 15%. Looking ahead, both estimated

revenue and net profit growth of the local EMS for CY20E are also more

superior at 10% and 14% respectively, way ahead of the regional peers’

single-digit growth of 6%.

0%

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Key customer ATA VS SKP i-Stone MTAG

3-year revenue CAGR 3-year core net profit CAGR

10 October 2019


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Fig 12: The local EMS sector’s 10-year forward PER

Source: Company, Bloomberg, Affin Hwang forecasts

Fig 13: The local EMS sector’s 5-year forward PER


Fig 14: The regional EMS sector’s 10-year forward PER

Source: Company, Bloomberg

Fig 15: 10-year PER spread between local and regional EMS


Top pick: ATA IMS (BUY, TP: RM1.80)

We initiate coverage on ATA (BUY, TP: RM1.80) and VS (BUY, TP:

RM1.60), given their attractive valuation and growth prospects. While both

have their own distinctive competitive advantages, we prefer ATA given it

is a purer proxy to its key customer. Elsewhere, while we also like VS for

its strong ability in securing new customers and believe the group is poised

to become a prime beneficiary of trade diversion among the three EMS

players, we remain cautious on its China operations which is expected to

remain a drag to the group’s operations due to the underutilization of its

facilities as a result of intensive competition and US-China trade tension,

though the losses are expected to narrow going forward.

Fig 16: Peer Comparison


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Spread (LHS) Local EMS PE (RHS) Regional EMS PE (RHS)(x) (x)



ATA IMS* BUY 1.45 1.80 24.1 1,746.3 14.3 12.9 14.8 10.6 24.9 8.9 8.7 7.6 2.5 2.2 19.0 2.5

V.S. Industry* BUY 1.26 1.60 27.0 2,314.0 13.8 12.6 8.9 9.5 (2.0) 6.0 7.5 6.4 1.4 1.3 10.8 3.4



Average 13.6 11.8 3.4 15.5 7.6 9.7 7.3 6.3 1.8 1.7 14.0 3.5




Average 14.2 11.9 77.7 17.9 29.6 6.4 14.0 11.2 n/a 2.7 19.7 n/a


PER premium justified given the strong growth

of the local EMS players

10 October 2019


Page 15 of 54

Key Investment Risks

Dependent on single major customer. Having a major key customer

which accounts for a big portion of total revenue, the fortunes (or lack

thereof) of the EMS players are highly dependent on the performance and

number of orders received from that particular key customer. A significant

reduction in number of orders from the key customer or losing the key

customer could materially and adversely impact their financial

performance.

Reliance on foreign labour. The EMS industry is highly dependent on

foreign labour for their operations. Any increase in minimum wage or

shortage in labour supply in Malaysia could raise its operating costs and/or

disrupt its operations.

Competition risk. The EMS industry is highly competitive with the

contract manufacturers having low bargaining power against its key

customer. The key customer may reallocate its research and development

spending to another segment of products or reallocate its production line

to another contract manufacturer. The introduction of lower-priced

competition or significant price reductions by any of the key customer’s

contract manufacturers could result in price reductions that would

adversely affect the EMS players’ business, financial condition and

operating results.

10 October 2019


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Initiation: Casting its net wider

ATA IMS (ATA) is the largest box-build contract manufacturer and filter

supplier to its key customer with the widest product range. We like

ATA for its: i) position as the prime proxy to its key customer – a

prominent global household appliance brand, ii) strong order flow from

the key customer, iii) potential margin enhancement from vertical

integration, iv) superior ROE of 18%, v) solid earnings growth – 3-year

CAGR of 13% over FY19-22E, and vi) reasonable dividend yields of

c.3%. We initiate coverage on ATA with a BUY rating and 12-month

target price (TP) of RM1.80, based on a CY20E PER of 16x.

Riding on the growth of its key customer

ATA is the second largest home-grown EMS player in Malaysia. Over 80%

of ATA’s revenue is derived from its single largest customer and it is also

the largest box-build contract manufacturer and filter supplier to its key

customer. The pole position of ATA indicates the trust and relationships ATA

has built, as well as its capabilities and capacity for its key customer. Hence

we view ATA as the prime proxy to the strong growth prospects of its key

customer – which is a privately-owned multinational corporation (MNC).

Notably, the filter business is ATA’s key distinction against its other pure-

assembly contract manufacturing peers as the filter business commands

higher margin as compared to conventional box-build business.

Eyeing IoT-related opportunities from trade diversion

While ATA expects continued strong growth for its key customer with the

introduction of new products going forward, it is not resting on its laurels

and continues to pursue diversification in areas of product and customer

mix, with preference towards Internet of Things (IoT) related, to tap on the

opportunities arising from trade diversion.

Initiate coverage with a BUY rating and TP of RM1.80

We initiate coverage with a BUY rating and TP of RM1.80, based on 16x

CY20E PER, which is in line its 1-year forward PER mean. Currently

trading at only 12x CY20E PER, valuation looks appealing vs. its 3-year

CAGR of 13%. We view the recent share-price pullback on concerns on

higher set-up expenses for new product and labour costs as an

opportunity for investors to accumulate shares to ride on its future growth

once the new lines operate at more efficient rates.

Earnings & Valuation Summary FYE 31 Mar 2018A 2019A 2020E 2021E 2022E

Revenue (RMm) 2,306.6 2,908.6 3,378.1 3,778.9 4,231.0

EBITDA (RMm) 145.1 187.1 205.1 227.4 255.2

Pretax profit (RMm) 108.1 150.8 165.3 188.6 215.8

Net profit (RMm) 74.4 111.3 122.3 139.6 159.7

EPS (sen) 8.2 9.4 10.2 11.6 13.3

PER (x) 17.7 15.5 14.3 12.5 10.9

Core net profit (RMm) 74.4 111.3 122.3 139.6 159.7

Core EPS (sen) 6.5 9.2 10.2 11.6 13.3

Core EPS growth (%) (21.7) 42.5 10.0 14.1 14.4

Core PER (x) 22.4 15.7 14.3 12.5 10.9

Net DPS (sen) - 3.3 3.6 4.1 4.6

Dividend Yield (%) - 2.3 2.5 2.8 3.2

EV/EBITDA (x) 11.5 9.8 8.4 7.4 6.4

Chg in EPS (%) - - -

Affin/Consensus (x) 0.96 0.93 0.93 Source: Company, Affin Hwang forecasts, Bloomberg

Initiate Coverage

ATA IMS AIB MK Sector: EMS

RM1.45 @ 9 October 2019

BUY (Initiate Coverage) Upside: 24%

Price Target: RM1.80 Previous Target: -

Price Performance

1M 3M 12M Absolute 7.4% -9.9% -14.7% Rel to KLCI 11.1% -2.3% -2.4%

Stock Data

Issued shares (m) 1,204.4 Mkt cap (RMm)/(US$m) 1746.3/416.1 Avg daily vol - 3mth (m) 0.6 52-wk range (RM) 1.32-1.88 Est free float 29.1% BV per share (RM) 0.54 P/BV (x) 2.67 Net cash/(debt) (RMm)

(3Q17)

(91.92) ROE (2020E) 18.3% Derivatives No Shariah Compliant Yes

Key Shareholders

Dato’ Seri James Foo 33.7% Dato’ Fong Chiu Wan 26.1% Balachandran 8.7% Source: Company, Bloomberg

Chua Yi Jing (603) 2146 7546

[email protected]

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(RM)

10 October 2019


Page 17 of 54

Investment Thesis

#1. Purest proxy to the prominent global

household appliance brand’s growth prospects

Riding on the growth of its key customer

ATA has been working closely with its key customer since 2003, starting as

a sub-contractor for the latter. The group subsequently became one of the

main contract manufacturers for its key customer in 2008. Notably, ATA

was awarded the Contract Manufacturer Award of the Year for the third

time in 2018 by this key customer. At present, over 80% of ATA’s revenue

is derived from its single largest customer. Over the past four years, ATA

recorded a 4-year revenue CAGR of 22%, mirroring its key customer’s 4-

year revenue CAGR of 33% (Figs 17). Going forward, we expect ATA’s

future growth to be driven by its anticipated robust product pipeline on the

back of its key customer’s revolutionary technology, continuous product

innovation and investment in R&D.

Fig 17: ATA’s revenue over the past five years

*Motor component-related revenue was excluded for FY15 and FY16 as it was recorded in both revenue and COGS with no value added. The motor components are supplies on a consignment basis and no longer captured as revenue nor COGS since FY17. Source: Company, Affin Hwang

Largest box-build contract manufacturer to its key customer…

ATA has the biggest market share among its key customer’s contract

manufacturers with around one-third market share of its key customer’s

global box-build production (in term of volume), while the remaining two-

thirds are produced by the other five contract manufacturers. As its key

customer’s largest box-build contract manufacturer, we think that ATA is

well-positioned as the prime proxy to the innovation and strong growth

prospects of its key customer – the privately-owned global household

appliance brand.

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RM m

10 October 2019


Page 18 of 54

… with the widest product range

Not only being the largest contract manufacturer to its key customer, ATA

is also the contract manufacturer that covers the widest range of its key

customer’s product offerings. ATA produces around five out of the six

products introduced by its key customers (Fig 18).

Fig 18: Types of product assembled by the three listed EMS players for their

common key customer

ATA IMS V.S. Industry SKP Resources

Floor care products ✔ ✔ ✔

Personal care products ✔ ✔ ✔

Air treatment products ✔ ✘ ✘

Environmental products ✔ ✘ ✔

Lighting ✔ ✘ ✘

Hand dryers ✘ ✘ ✔ Source: Affin Hwang estimates

Not forgetting the filters!

In addition to being the largest box-build contract manufacturer which

produces the broadest product range for its key customer, ATA is also the

largest supplier of filters for its key customers’ household appliances,

making up around 75% of its requirement globally. This is ATA’s key

distinction against its other pure-assembly contract manufacturing peers as

filter business commands higher margin as compared to conventional box-

build business. Filters serve as a major component in keeping the floor

care and air treatment products running efficiently by ensuring the harmful

ultrafine particles stay trapped in the filter media.

#2. Riding on the growing demand for its key

customer’s household appliances

Continuous substantial order flow witnessed

Earlier, we have highlighted the potential strong demand for high-tech

household appliances (please refer to page 6-8 of the report). At ATA, we

have seen consistent strong order flow from the key customer in recent

years with the latest products including floor-care (commenced in January

2019) and environmental products (commenced in March 2019). With the

key customer’s target of developing 100 new products by 2020, we think

ATA stands strong as a prime beneficiary among its peers for its key

customer’s robust growth.

More projects in the pipeline

Currently, ATA has 3 new projects in the pipeline with its key customer,

which should continue to drive the group’s growth momentum. Of the 3

new projects, one is a new personal care product which is expected to

commence production by the end of 2019, while another new project is

expected to commence production in 2020. Besides, the third new project

is an upgraded version of an existing model for which the timeline is still

unknown. All these 3 new projects are not out in the market yet at this

junction. The new projects will continue to drive the group’s revenue

growth which we estimate to be around 12-18% for FY20-22E. As usual,

management remains tight-lipped on the details/features of the new

products due to the commercial arrangement with the key customer. Going

10 October 2019


Page 19 of 54

forward, the group remains committed to continue bidding for more

projects and growing together with its key customer.

Margin to be affected in the short term but recovery on the way

Near-term margins are expected to be affected due to the initial learning

curve, but will likely improve going forward once the production lines are

running at optimal rate. Recall that the group’s core net profit margin

deteriorated to 2.0% in 4QFY18 (from 4.2% in 4QFY17) due to the start-up

expenses for new products, and subsequently recovered to 4-6% in the

subsequent quarters. Similarly, the core net profit margin declined to 2.9%

in 1QFY20 (from 5.8% in 1QFY19). We expect the margin to recover

gradually going forward as the new assembly lines become more efficient.

Expansion for future growth

In FY19, ATA acquired 2 additional factories which successfully increased

its production space by 49% to 1.15m sq. ft., while in FY20 the group

leased 1 additional factory which expanded its production space by 10% to

1.26m sq. ft. For the final assembly line, it has invested in 2 new final

assembly lines (growing from 12 to 14) to cater for the commencement of

new products in FY20E. While the group expects a normalised capex

following the huge investment of RM113m in FY19, it remains committed

and is ready to continue ramping up its production capacity to cope with

any expected increase in orders from its key customer should the capacity

be fully utilised.

Fig 19: Capacity expansion

FYE 31 Mar FY18 FY19 FY20

No. of facilities 22 25 26

No. of assembly lines 8 12 14

Production space (sq. ft.) 774k 1.15m 1.26m

Warehouse space (sq. ft.) 210k 328k 328k

Total space (sq. ft.) 984k 1.48m 1.59m Source: Company, Affin Hwang

#3. Vertical integration to enhance capabilities &

profitability

Started PCB assembly and battery pack assembly divisions

The major shareholders of ATA, who are also part of the management

team, have separately established a private company, Microtronics

Technology Sdn Bhd (MTSB), to do printed circuit board (PCB) assembly

and battery pack assembly in 2017, prior to the reverse takeover exercise.

According to the management, MTSB was not injected together with IMS

Group into the listed Denko Industrial Corporation when the reverse-

takeover exercise was undertaken because it was still in the process of

setting up the divisions, bringing in machineries, and undergoing

qualification by its key customer, and hence was in the red which could be

a drag to the group’s profitability.

To add on PCB assembly and battery pack assembly, as well as…

Post-qualification by the key customer, MTSB started operations in

October 2018 and achieved breakeven recently. Currently it has 14

surface-mount technology (SMT) lines, which are able to fulfil around 60%

of ATA’s PCB and battery pack requirements, with the remaining still

10 October 2019


Page 20 of 54

sourced from its peer. It plans to increase this to 18 lines by the end of the

year, with a target to develop self-sufficiency. The shareholders plan to

fully integrate the divisions under the private arm into the listed ATA group,

by mid-2021. We acknowledge that this will be a possible related-party

transaction (RPT) in the future.

… wire harness and brush bar assembly to its core competencies

In addition, ATA is also looking to add another two capabilities, namely

wire harness and brush bar assembly to the group, which it currently

purchases from third-party suppliers. The group has submitted brush bar

samples to undergo testing by its key customer, while its wire harness site

is being audited by the key customer. Both capabilities are expected to

commence production in early CY2020. With the wire harness and brush

bar produced in-house, this will save on the group’s average annual

purchases of about RM230m from external suppliers and the cost savings

arising will eventually enhance its margin and bottom line.

Vertical integration – a win-win situation for ATA & its key customer

The integration of new capabilities will help improve the group’s profitability

as the manufacturing of components typically command higher margins as

compared to box-build assembly. Most importantly, vertical integration will

pave the way for more contracts as it will not only benefit ATA but also lead

to significant savings on logistics and packaging costs to its key customer.

With more component parts manufactured in-house by its box-build

contract manufacturers, it helps the key customer eliminate the hassle of

outsourcing component parts from various vendors. In addition to vertical

integration, ATA is exploring more automation to enhance manufacturing

and cost efficiency. Based on our sensitivity analysis, every 0.1ppt

enhancement to the group’s core net margin will lead to c.3% increase in

core net profit in FY20-22E.

#4. Eyeing opportunities from trade diversion

Customer diversification opportunities on the back of trade tension

While ATA expects continued strong growth for its key customer with the

introduction of new products going forward, it is not resting on its laurels

and continues to pursue diversification in areas of customer mix and

product, with preference towards Internet of Things (IoT) related, to tap on

the opportunities arising from trade diversion as a result of US-China trade

standoff. The group has been actively exploring the opportunities and is

currently in discussion with a number of prospective customers. As one of

the world’s Top 30 EMS companies by revenue (ranked by Manufacturing

Market Insider list of Top EMS providers in 2018), we think that ATA

should have the ability to secure new customers, though it may take some

time as it prefers to be prudent and selective in term of bringing in new

customers.

Looking to diversify into IoT space, but may take time

ATA is exploring the IoT space, particularly smart home appliances, as the

products usually consist of a mix of electronic and mechanical components

which fits well with the group’s vertically integrated capabilities. The group

is in collaboration with Canada’s Swift Labs, which specializes in wireless

and IoT hardware development, system integration and testing services,

10 October 2019


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for Original Design Manufacturers (ODM) to tap on the latter’s capabilities

and wide customer base. Some of the partner’s customers are renowned

large corporations such as Wistron, Hyundai Mobis, SanDisk, Clearpath

Robotics, and ecobee. Currently, the group is in quotation and feedback

stage for some projects, hence prefers to remain tight-lipped on the

quantum and details of the contracts. That said, we still expect any new

projects to take around 1-2 years to fully materialise as this is a relatively

new venture to the group. Thus contribution, if any, is likely to be negligible

over the near term.

IoT future looks promising

According to International Data Corporation’s (IDC) recent publication of its

latest Worldwide Semiannual Internet of Things Spending Guide,

worldwide technology spending on the IoT is expected to grow at a CAGR

of 13.6% over the 2017-2022 forecast period and reach US$1.2trn in 2022.

With the introduction of 5G technology which promises to provide data

transmission speeds over wireless broadband networks of up to 20Gbps,

20 times faster than 4G networks, the IoT future looks promising. The

forecast also highlights that the consumer sector will lead IoT spending

growth with a worldwide CAGR of 19% (Fig 20).

Fig 20: Top 5-year CAGR (2017-2022) industries

Source: IDC Worldwide Semiannual Internet of Things Spending Guide, 2017H2

19.0%

17.5%16.9%

16.1%14.9%

12.3%

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10 October 2019


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Financial Analysis and Forecasts

Strong revenue and core net profit growth

ATA recorded an encouraging 4-year revenue and core net profit CAGR of

27% and 23% respectively through FY19, driven by growing orders and

product range from its key customer. Notably, the group had achieved a

record-high financial performance in FY19, which saw its core net profit

crossing the RM100m mark for the first time on the back of close to RM3bn

in revenue. In terms of growth, its revenue and core net profit surged by

26% and 50% respectively in FY19.

1QFY20: Waylaid by new lines’ start-up expenses

ATA reported a strong revenue growth of 45% yoy in 1QFY20, mainly

driven by higher sales orders and new projects from its key customer.

However, core net profit declined 29% yoy due to i) lower efficiency and

higher start-up cost of new assembly lines that came on stream, ii) higher

material contents for new models, and iii) higher labour cost as a result of

the minimum wage hike which was not fully passed on to the key customer

given the strong competition. Consequently, its core net profit margin

declined to 2.9% in 1QFY20, from 5.8% in 1QFY19.

Still a growth year despite near-term headwinds

While we expect a lower core net profit margin of 3.6% for full year FY20E

(from 3.8% in FY19) mainly dragged by: i) higher start-up cost of new

assembly lines and ii) higher labour cost as a result of minimum wage hike

which was not fully passed on to the key customers given the strong

competition, we see limited downside risk from its 1QFY20 core net profit

margin of 2.9% and expect the margin to recover gradually in the coming

quarters as the new assembly lines become more efficient. Overall we

think full-year FY20E will still be a growth year despite near-term

headwinds. On a positive note, we believe the group’s revenue growth

prospects remain intact, mainly driven by with higher box-build orders from

its key customer.

Expecting 3-year core net profit CAGR of 13%

We project ATA to record a 3-year core net profit CAGR (FY19-22E) of

13%, driven by: 1) growing orders from its existing key customer, 2)

improving economies of scale and better operating efficiencies post the

learning curve and after achieving full efficiency as the new assembly lines

go into full swing, and 3) higher margin as a result of vertical integration.

Any potential contract wins from new customers as a result of the US-

China trade tension could provide upside to our earnings forecast.

10 October 2019


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Fig 21: Projecting 13% 3-year revenue CAGR (FY19-22E)

Source: Company, Affin Hwang forecasts

Fig 22: Projecting 13% 3-year core net profit CAGR (FY19-22E)

*Note: Core net profit margin was much higher in FY17 mainly due to the lower effective tax rate as a result of the utilisation of tax incentives given by the government for hitting a certain sales target. Source: Company, Affin Hwang forecasts

Plenty of headroom for gearing up

ATA has spent significant capex of RM122m and RM113m in FY18 and

FY19 respectively, mainly to acquire new facilities and production lines for

expansion. To finance the expansion, the group has undertaken additional

borrowings of RM203m, and private placement of 5% of its issued share

capital with RM96m in funds raised. Post-expansion, management expects

its capex to normalise to around RM50-55m per year over the next three

years. The group sits on a heathy cash pile of RM271m with comfortable

net gearing of 0.14x as at end-FY19, which allows it to have ample

flexibility to gear up for future expansion, if necessary. Moreover, in view of

the strong take-up rate for its private placement in March 2019 (close to 3x

oversubscription), the group should be able to tap on the equity market to

raise funds for expansion, if needed.

Dividend payout to reward investors

Despite not having a formal dividend policy in place, ATA indicated that it

aims to maintain a minimum dividend payout of 35%. Following the

reverse takeover in 2018, ATA has declared a maiden dividend of

3.29sen/share for FY19. For FY20-22E, we forecast a dividend payout of

35%, translating to an average yield of around 3%.

Lowest margin among its closest peers, but striving to improve by

adding vertical capabilities

ATA has the lowest core net profit margin among its closest peers given its

highest reliance on their common key customer (Fig 23). On a positive

note, while the profitability from the key customer is significantly lower than

its other customers, the key customer provides significantly larger

production volume vis-à-vis ATA’s peers. Moreover, its margin should

improve going forward as it adds more capabilities such as PCB assembly,

battery pack assembly, wire harness and brush bar assembly to its core

competencies.

Fig 23: Historical core net margin trend

FY17 FY18 FY19

ATA IMS 4.7% 3.2% 3.8%

VS Industry 5.1% 3.7% 4.2%

SKP Resources 5.4% 5.6% 5.7%

Average 5.1% 4.1% 4.6%

Source: Company, Affin Hwang

0%

5%

10%

15%

20%

25%

30%

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

FY17A FY18A FY19A FY20E FY21E FY22E

RM m Revenue (LHS) Revenue growth (RHS)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

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4.5%

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-

20

40

60

80

100

120

140

160

180

FY17A FY18A FY19A FY20E FY21E FY22E

RM m Core net profit (LHS) Core net profit margin (RHS)

10 October 2019


Page 24 of 54

Valuation and Recommendation

Initiate with a BUY rating and TP of RM1.80

We initiate coverage on ATA with a BUY rating and 12-month TP of

RM1.80. Our TP is based on 16x CY20E PER, which is in line with its 1-

year forward PER mean. We like ATA for its: 1) position as the key

customer’s largest box-build supplier in the world, producing most of its

key customer’s product offerings, 2) growing orders from its key customer,

3) aspiration to be vertically integrated, 4) superior ROE of 18%, 5) solid

earnings growth – 3-year CAGR of 13% over FY19-22E, based on our

estimates, and 6) reasonable dividend yields of c.3%.

Prior valuation not reflective of current business model

Only 1-year historical forward PER is available as the reverse takeover

exercise was only conducted a year ago, and the PER prior to this was not

reflective of its current business model (annual revenue is 22x higher,

market cap is 4x larger post-reverse takeover). Moreover, the group prior

to the reverse takeover was not profitable for six years over the past 10

years, hence PER may not be a useful metric to value its historical

valuations.

Opportunity to buy at trough

ATA’s share price fell as much as 21% recently following the

announcement of its weaker-than-expected quarter results and the cut in

consensus earnings forecast in anticipation of potential higher set-up

expenses for new product and labor costs. Currently trading at only 12x

PER to its CY20E EPS, we think that the share-price correction has

reflected the potential near-term earnings weakness and the valuation

looks appealing vs. its 3-year CAGR of 13%, with reasonable average

dividend yields of c.3% for FY20-22E. We think that the recent share-price

weakness serves as a good buying opportunity for investors to accumulate

shares to ride on its future growth once the new production lines fully ramp

up and operate at more efficient rates.

Fig 24: ATA’s 1-year forward PER

Source: Bloomberg, Affin Hwang forecasts

11.0

12.0

13.0

14.0

15.0

16.0

17.0

18.0

19.0

20.0

Fe

b18

Ma

r18

Apr1

8

Ma

y1

8

Jun1

8

Jul1

8

Aug

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Sep

18

Oct1

8

Nov18

Dec18

Jan1

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Fe

b19

Ma

r19

Apr1

9

Ma

y1

9

Jun1

9

Jul1

9

Aug

19

Sep

19

(x)

+2 SD: 18.7x

+1SD: 17.3x

Avg: 15.9x

-1SD: 14.5x

-2 SD: 13x

10 October 2019


Page 25 of 54




Downside risks include: i) dependent on single major customer; ii) reliance

on foreign labor, iii) competition risk, iv) liquidity risk of stock as over 90%

of the shareholdings are held by the management and institutional funds,

v) a downturn in the household appliances industry, and vi) a slowdown in

the economy.



ATA IMS* BUY 1.45 1.80 24.1 1,746.3 14.3 12.9 14.8 10.6 24.9 8.9 8.7 7.6 2.5 2.2 19.0 2.5

V.S. Industry* BUY 1.26 1.60 27.0 2,314.0 13.8 12.6 8.9 9.5 (2.0) 6.0 7.5 6.4 1.4 1.3 10.8 3.4



Average 13.6 11.8 3.4 15.5 7.6 9.7 7.3 6.3 1.8 1.7 14.0 3.5




Average 14.2 11.9 77.7 17.9 29.6 6.4 14.0 11.2 n/a 2.7 19.7 n/a


10 October 2019


Page 26 of 54

Company background

A reverse takeover to create a whole new EMS player

ATA IMS (formerly known as Denko Industrial Corporation) was incorporated in Malaysia in 1989 and listed on Bursa Malaysia in 1991. The group changed its name from Denko Industrial Corporation to ATA IMS after the reverse acquisition by Integrated Manufacturing Solution Group (IMS Group) in 2018. Similar with Denko’s business, IMS Group, founded by Dato’ Sri Foo Chee Juan and Dato’ Fong Chiu Wan in 1991, is principally involved in manufacturing and sales of precision plastic injection moulded parts, air filters and sterilisers, assembly of electrical and electronics components and products, and design and fabrication of tools and moulds, serving the electrical and electronics industry. The group carries decades of experience and expertise in various industries including consumer appliances, environmental care, lighting, automotive and healthcare. In addition to the key customer that accounts for over 80% of the group’s revenue, ATA also has other minor customers that collectively make up less than 10% of its total revenue, including Pioneer, Kenwood, Schneider Electric and Autoliv. Fig 26: Major milestones

Year Major Milestones

1989 Incorporated in Malaysia under the name of Ecodynamic (M) Sdn Bhd

1990 Changed its name to Denko Industrial Corporation Sdn Bhd

Converted into a public listed company

1991 Listed on Bursa Malaysia

2018 Reverse acquisition by Integrated Manufacturing Solutions Sdn Bhd and its subsidiaries (IMS Group)

Changed its name from Denko Industrial Corporation Berhad to ATA IMS Berhad

2019 Incorporation of ATA Components Sdn Bhd. The principal activities of ATA Components Sdn Bhd are manufacture of all kinds of components relevant to electronics or electrical products, mechanical or consumer products and any kind of industrial components, e.g. wire harness and brush bar assembly.


Manufacturing facilities and warehouses Headquartered in Johor Bahru, ATA has 26 manufacturing facilities and

warehouses, with around 1.26m sq. ft. of production space and 0.3m sq. ft.

of warehouse space. It has in recent years completed a number of

expansions including a 5-story detached factory with office for production

at Jalan Dewani (built-up area: 187k sq. ft.), 3-story detached factory with a

new warehouse with high ceiling (built-up area: 116k sq. ft.), new spray

facility which houses advanced robot and spindle arms, and new plastic

injection facility which houses 58 injection machines. Going forward, it will

continue to invest in automation to improve its production efficiencies.

Experienced management team

Following the completion of the reverse take-over, ATA IMS is now helmed

by Dato’ Seri James Foo (Executive Chairman & Executive Director), Dato’

Fong (Chief Executive Officer & Executive Director) and Balachandran

(Chief Operating Officer & Executive Director). The trio collectively own

around 67% in the group, with Dato’ Seri James Foo being the largest

shareholder with a 34% stake followed by Dato’ Fong with a 26% stake

and Balachandran with a 7% stake.

10 October 2019


Page 27 of 54

Fig 27: Experienced management team with strong industry expertise Key Management Personnel Profile

Dato’ Seri James Foo Chee Juan Aged 58, Singaporean Executive Chairman & Executive Director

Has more than 25 years of experience in the manufacturing and sale of precision plastic injection moulded parts and assembly of electrical and electronic components and products. Established ATA Industrial (M) Sdn Bhd in 1991. Joined ATA Industrial Pte Ltd in 1991 as a business development manager. Graduated from the University of Oregon with a Degree in Bachelor of Science, major in Finance and Marketing.

Dato’ Fong Chiu Wan Aged 56, Singaporean Chief Executive Officer & Executive Director

Has more than 30 years of experience in the manufacturing and sale of precision plastic injection moulded parts and assembly of electrical and electronic components and products. Established ATA Industrial (M) Sdn Bhd in 1991. Joined ATA Industrial Pte Ltd in 1987 as general manager. Graduated from the University of Oregon with a Degree in Bachelor of Arts.

Balachandran A/L Govindasamy Aged 45, Malaysian Chief Operating Officer & Executive Director

Has 24 years of work experience in the electronics manufacturing sector and has been with ATA Industrial (M) Sdn Bhd for the last 18 years. Graduated with a Diploma in Electronics from Federal Institute of Technology, Malaysia, and is a Qualified Lead. Assessor upon completion of his training in Advanced Environment Management Systems Auditing Course.


10 October 2019


Page 28 of 54

Fig 28: Design & Engineering Solutions

Source: Company

Fig 29: Mould Design & Fabrication

Source: Company

Fig 30: Plastic Injection Moulding

Source: Company

Fig 31: Sub & Full Assembly

Source: Company

Fig 32: Secondary Process

Source: Company

Fig 33: Surface Mount Technology (SMT)

Source: Company

10 October 2019


Page 29 of 54

ATA IMS – FINANCIAL SUMMARY


Profit & Loss Statement Key Financial Ratios and Margins

FYE 31 Mar (RM m) 2018A 2019A 2020E 2021E 2022E FYE 31 Mar (RM m) 2018A 2019A 2020E 2021E 2022E

Revenue 2,307 2,909 3,378 3,779 4,231 Growth

Operating expenses -2,162 -2,721 -3,173 -3,552 -3,976 Revenue (%) 27.1 26.1 16.1 11.9 12.0

EBITDA 145 187 205 227 255 EBITDA (%) 32.9 29.0 9.6 10.9 12.2

Depreciation -14 -25 -27 -30 -33 Core net profit (%) -13.0 49.6 10.0 14.1 14.4

EBIT 131 162 178 197 222

Net int income/(expense) -3 -9 -12 -8 -6 Profitability

Exceptional gains / (losses) -20 -2 0 0 0 EBITDA margin (%) 6.3 6.4 6.1 6.0 6.0

Pretax profit 108 151 165 189 216 PBT margin (%) 4.7 5.2 4.9 5.0 5.1

Tax -34 -40 -43 -49 -56 Net profit margin (%) 3.2 3.8 3.6 3.7 3.8

Minority interest 0 0 0 0 0 Effective tax rate (%) 31.2 26.2 26.0 26.0 26.0

Net profit 74 111 122 140 160 ROA (%) 7.9 8.1 7.3 8.0 8.5

Core net profit 74 111 122 140 160 ROE (%) 23.6 21.2 18.3 18.5 18.7

ROCE (%) 29.0 20.6 17.7 19.1 20.6

Balance Sheet Statement Dividend payout ratio (%) 0.0 35.1 35.0 35.0 35.0

FYE 31 Mar (RM m) 2018A 2019A 2020E 2021E 2022E

Fixed assets 209 297 324 344 360 Liquidity

Other long term assets 76 76 76 76 76 Current ratio (x) 1.3 1.4 1.5 1.6 1.6

Total non-current assets 285 373 401 420 437 Op. cash f low (RM m) 74 -46 216 140 159

Cash and equivalents 155 271 329 320 323 Free cashflow (RM m) 42 -108 161 90 109

Stocks 127 218 201 225 251 FCF/share (sen) 4.1 -9.4 13.4 7.5 9.0

Debtors 501 739 720 805 902

Other current assets 26 44 44 44 44 Asset management

Total current assets 808 1,272 1,294 1,394 1,521 Debtors turnover (days) 79.3 92.7 77.8 77.8 77.8

Creditors 506 634 665 744 833 Stock turnover (days) 21.4 29.2 23.1 23.1 23.1

Short term borrow ings 124 260 200 150 100 Creditors turnover (days) 85.5 85.0 76.5 76.4 76.4

Other current liabilities 0 4 4 4 4

Total current liabilities 630 898 869 898 937 Capital structure

Long term borrow ings 35 102 102 102 102 Net gearing (%) 1% 14% -4% -9% -13%

Other long term liabilities 7 14 14 14 14 Interest cover (x) 44.1 20.3 16.7 27.6 42.4

Total long term liab. 42 116 116 116 116

Shareholders' Funds 422 630 710 800 904

Minority Interest 0 0 0 0 0 Quarterly Profit & Loss

FYE 31 Mar (RM m) 1Q19 2Q19 3Q19 4Q19 1Q20

Cash Flow Statement Revenue 577 692 837 803 836

FYE 31 Mar (RM m) 2018A 2019A 2020E 2021E 2022E Operating expenses -530 -648 -786 -756 -794

Pretax Profit 128 152 165 189 216 EBITDA 46 43 51 47 42

Depreciation & amortisation 14 25 27 30 33 Depreciation & amortization -6 -6 -7 -7 -7

Working capital changes -32 -205 67 -30 -34 EBIT 41 37 44 40 35

Cash tax paid -37 -27 -43 -49 -56 Int expense -2 -2 -3 -3 -2

Others 1 8 0 0 0 Exceptional items 3 2 -2 -4 -1

C/F from operation 74 -46 216 140 159 Pretax profit 39 35 42 37 33

Capex -32 -62 -55 -50 -50 Tax -9 -8 -8 -15 -8

Others 6 13 0 0 0 Minority interest 0 0 0 0 0

C/F from investing -26 -49 -55 -50 -50 Net profit 31 27 34 21 25

Debt raised/(repaid) 9 164 -60 -50 -50 Core net profit 33 29 32 17 24

Dividends paid 0 0 -43 -49 -56

Others -57 56 0 0 0 Margins (%)

C/F from financing -47 220 -103 -99 -106 EBITDA 8.0 6.2 6.1 5.8 5.0

Net change in cash flow 1 125 59 -9 3 PBT 6.8 5.1 5.0 4.6 3.9

Net profit 5.3 4.0 4.0 2.6 2.9

Free Cash Flow 42 -108 161 90 109

10 October 2019


Page 30 of 54

Initiation: Prime beneficiary of trade diversion

V.S. Industry (VS) is the largest home-grown vertically integrated

Electronics Manufacturing Services (EMS) player in Malaysia. We like

VS for its: i) diversified customer mix, ii) strong ability in securing new

contracts which makes it a prime beneficiary of trade diversion, iii)

earnings growth on the back of new orders and potential narrowed

losses from its China operations, and iv) reasonable dividend yields

of 3-4%. We initiate coverage on VS with a BUY rating and 12-month

target price (TP) of RM1.60, based on CY20E PER of 16x.

The most diversified local EMS player among its closest peers

VS has the most diversified customer mix among its closest peers, with its

three major MNC customers collectively making up more than 70% of its

revenue in FY19. Most importantly, all three major customers are involved

in different industries, alleviating the common concern on the concentration

risk investors have for EMS players. In addition, with its diversified

customer mix, VS stands a high chance of gaining more market share from

its existing customers’ contract manufacturers.

Strong ability in clinching new orders

Following the decline in order flow from its single largest key customer, VS

has managed to secure a new customer, Bissell, to partly fill the gap within a

remarkably short period. With the recent contract wins demonstrating its

strong ability in clinching new contracts, we believe that VS is at the forefront

of securing more orders from the trade diversion. Besides, despite the

reduction in orders from its key customer, VS’ recent quarters results were

above market expectations due to the improved production efficiency

arising from greater economies of scale, the absence of set-up costs of

new lines and more favorable product mix. While VS is also a victim of trade

tension with its operation in China, it is currently streamlining and downsizing

the operation to optimise cost and minimise losses.


We initiate coverage on VS with a BUY rating and TP of RM1.60, based

on 16x CY20E PER, in line with +0.5SD of its 5-year forward PER mean.

Currently trading at 13x CY20E PER, we think that the share-price

correction reflects the potential near-term weakness and the valuation

looks appealing at current levels.

Earnings & Valuation Summary

FYE 31 Jul 2018A 2019A 2020E 2021E 2022E

Revenue (RMm) 4,100.7 3,978.4 4,042.3 4,345.5 4,678.5

EBITDA (RMm) 285.5 294.4 328.1 357.7 386.1


Net profit (RMm) 149.9 166.0 174.7 192.9 211.7

EPS (sen) 9.3 8.6 9.6 10.6 11.6

PER (x) 13.6 14.6 13.1 11.9 10.8


Core EPS (sen) 9.2 9.1 9.6 10.6 11.6

Core EPS growth (%) (17.4) (1.2) 5.3 10.4 9.7

Core PER (x) 13.7 13.8 13.1 11.9 10.8

Net DPS (sen) 4.3 4.4 4.3 4.8 5.2

Dividend Yield (%) 3.4 3.5 3.4 3.8 4.1

EV/EBITDA (x) 8.0 8.0 6.8 6.0 5.3

Chg in EPS (%) - - -

Affin/Consensus (x) 0.99 0.94 0.99 Source: Company, Bloomberg, Affin Hwang forecasts

Initiate Coverage

V.S. Industry VSI MK Sector: EMS

RM1.26 @ 9 October 2019

BUY (Initiate Coverage) Upside: 24%

Price Target: RM1.60 Previous Target: -

Price Performance

1M 3M 12M Absolute -2.3% 8.6% -24.6% Rel to KLCI 1.0% 17.8% -13.7%

Stock Data

Issued shares (m) 1,836.5 Mkt cap (RMm)/(US$m) 2314/551.4 Avg daily vol - 3mth (m) 11.0 52-wk range (RM) 0.63-1.70 Est free float 57.4% BV per share (RM) 0.87 P/BV (x) 1.45 Net cash/(debt) (RMm)

(3Q17)

(48.98) ROE (2020E) 10.6% Derivatives No Shariah Compliant Yes

Key Shareholders

KWAP 10.9% Datuk Beh Kim Ling 7.9% Datin Gan Chu Cheng 7.0% Datuk Gan Sem Yam 5.9% Source: Company, Bloomberg

Chua Yi Jing (603) 2146 7546

[email protected]

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Oct-16 Mar-17 Aug-17 Jan-18 Jun-18 Nov-18 Apr-19 Sep-19

(RM)

10 October 2019


Page 31 of 54

Investment Thesis

#1. Prime beneficiary of trade diversion

Lower order flow from key customer

While FY19 was supposed to be a year where VS’ earnings start to

accelerate strongly with most of the lines reaching full efficiency, the

expectations fell through following the decline in order flow from its single

largest key customer. In December 2018, VS announced in its 1QFY19

results that it had expected a decline in order flow from its key customer in

Malaysia, with no reason being cited. There was a reduction in orders for 3

lines of its floor care products.

3 lines taken away, but added 1.5 lines

While there was a reduction in orders for 3 lines of floor care products from

the key customer, VS has received 1 line of new additional orders from its

key customer for the latest version of floor care product and 0.5 line of

additional orders for a personal care product that is already in production

due to strong demand for the product. As a result, the net lower order flow

is only 1.5 lines. This has largely alleviated the concern on the risk of any

further reduction in order flow from the key customer and demonstrated

VS’ ability in securing new product orders with its experience and

expertise. Currently, it is running 3.5 lines for the key customer.

Impact from the decline in order flow less austere than expected

Following the profit warning, the market was expecting the group to report

weaker results; however, this did not materialise as the impact from the

reduction in orders was less severe than expected. Its Malaysian

operations recorded a stronger revenue (+10% yoy, +19% qoq) and pre-

tax profit (+68% yoy, +106% qoq) in 4QFY19. The better-than-expected

performance was mainly driven by: i) the improvement in production

efficiency stemming from greater economies of scale as more lines are

running optimally, ii) the absence of set-up costs associated with

commissioning of new lines that were incurred in the corresponding period

last year, and iii) more favorable product sales mix, particularly the key

customer’s personal care products which command higher ASP.

Bissell comes to the rescue…

Three months after the issuance of a profit warning back in March 2019,

VS made a surprise announcement of contract win from a new customer –

Bissell International Trading Company, B.V. (Bissell) in February 2019, to

manufacture home care products on a box-build assembly basis. Bissell’s

products are mainly manufactured in China and Mexico, and this product

transfer is mainly due to the US trade tariff on China. Per management, the

contract was secured within 6 months which is in a short time frame as

compared to a normal contract which takes around 18 months to secure.

This has undeniably demonstrated the group’s strong ability in clinching

new orders.

10 October 2019


Page 32 of 54

… but only partly offset the shortfall in the near term

That said, while Bissell came in on time to partly offset the decline in order

flow, and further diversify VS’ customer mix and reduce the concentration

risk, we note that in the short term the contribution from Bissell is still not

sufficient to fully cover the decline in order flow from the key customer.

Bissell is expected to contribute an estimated revenue of RM300m to the

group in FY20E (c.7% of the group’s revenue in FY20E).

Commenced mass production for its first Bissell model

VS has commenced the mass production for its first Bissell model, a water-

based carpet cleaner, at its 160,000 sq. ft. facility. The delivery will start by

end-October, hence we expect the contribution to be minimal in 1QFY20

and only come in progressively from 2QFY20 onwards. So far, a total of 5

models has been confirmed and will commence progressively once the first

production line stabilises. The group targets to break even on the set-up

cost for its Bissell production in December 2019.

More opportunities ahead from Bissell on the back of trade diversion

Bissell is one of the top-selling brands in small home-care products in the

USA with an estimated market share of 20%, recording close to US$1.0bn

of annual revenue in 2018. In addition to offering an array of homecare

products that include carpet cleaners, vacuums, sweepers, cleaning

formulas, and pet grooming & clean-up products, Bissell also provides

commercial cleaning equipment to various industries under the brand

Sanitaire, which was acquired from Electrolux. Bissell’s products are sold

in North and South America, Europe, the Middle East, and in Asia, such as

in Taiwan, Japan and China. Its contract manufacturers are located in

China and Mexico, and VS is its first contract manufacturer in Southeast

Asia. VS believes there is potential for more contract wins from Bissell and

expects Bissell to become its second largest customer, contributing around

20% to its annual revenue in three years’ time.

Fig 34: Bissell’s key product categories

Source: Company

10 October 2019


Page 33 of 54

Another contract win in the cards?

Eyeing a piece of the pie from the potential MNC’s supply-chain shift, VS

has established a special business development taskforce to pursue these

opportunities. Other than Bissell, VS also secured a new customer which is

expected to contribute around RM100m in annual revenue to the group.

The group is currently in advanced stages of discussions with a number of

other prospective customers, though the management remains tight-lipped

on the type of products/industries. With the group’s ability in securing new

orders within a shorter-than-expected period, we reckon that the group

stands a high chance in securing new customers, filling up its 180k sq. ft

new factory. Should new orders come to fruition, it would further diversify

VS’ customer mix and enable the group to regain investors’ confidence.

Based on our sensitivity analysis, every RM100m new contract from a new

customer could potentially increase the group’s core net profit by c.2-3%

for FY20-22E.

#2. The most diversified local EMS player

among its closest peers

A well-diversified customer mix

Among the three largest home-grown EMS players in Malaysia, VS has the

most diversified customer mix, with its three major customers collectively

making up close to 90% and 75% of its Malaysia’s and group’s revenue

respectively in FY19. Mostly importantly, all three major customers are

involved in different industries (Fig 35). Based on our estimates, given the

decline in order flow from its single largest key customer, the reliance on

the particular key customer will constitute less than half of the group’s total

revenue from FY20E onwards (from more than half of the group’s revenue

in FY19). With the inclusion of Bissell, for which production commenced in

September 2019, the group’s customer mix will become even more well-

distributed, alleviating the common concern on the concentration risk

investors have for EMS players.

Fig 35: Profile of top four major customers

Customer Profile

Global renowned premium household appliances brand

Single largest key customer* Customer since 2011

2 types of contracts on hand: 1) box-build assembly, and 2) PCB & battery pack assembly

Leader in the North American market for single-serve coffee selling coffee pods and brewers

Customer since 2012

VS serves as OEM & ODM

VS is 1 of 3 suppliers to Keurig and the only one out of China

Leading supplier of pool cleaners with key markets in Australia, US and South Africa

Customer since 2013

VS serves as OEM & ODM

VS is the sole manufacturer of Zodiac’s robotic pool cleaner in the world

One of the top-selling brands in small homecare products in the USA

Latest customer secured in 2019

VS is Bissell's first supplier in Southeast Asia *Unable to disclose actual name due to the companies’ commercial arrangement with the key customer Source: Company, Affin Hwang

10 October 2019


Page 34 of 54

Fig 36: Revenue breakdown by customer mix and segment


Fig 37: Revenue contributions from top three major customers


Backed up by renowned MNC customers

VS’ order flow from both Keurig Dr Pepper (Keurig) and Zodiac Pool

Solutions (Zodiac) have been growing strongly at a CAGR of 63% and

51% respectively since the first year they appointed VS as contract

manufacturer, which signals their confidence in VS’ quality and delivery.

VS currently serves Keurig and Zodiac in both the OEM and ODM spaces.

Notably, Zodiac closed down its plants in France and Australia in 2014 and

2015 respectively and moved their production volume to VS after

outsourcing orders to VS and being satisfied with the latter’s competitive

pricing and quality where market rejection rates are much lower. VS is now

the sole producer of Zodiac’s robotic pool cleaners in the world and has

started producing other pool cleaning-related products such as

chlorinators.

Fluidra-Zodiac merger…

In mid-2018, Zodiac completed a merger with Fluidra, a multinational

Spanish-listed company involved in the manufacturing of pool equipment

products, as well as in industrial water treatment, irrigation and engineering

services, to create a global leader in the pool sector. The combined

company has retained the Fluidra name and turned into a global

powerhouse with presence in over 45 countries and 30-40% combined

market share in robotic cleaners in the European Economic Area (EEA),

according to a press release by Fluidra (Fig 38). Fluidra owns a portfolio of

some of the industry’s most recognized and trusted brands, including

Jandy, AstralPool, Polaris, Cepex, Zodiac, CTX Professional and Gre.

Objectives set by the company for 2022E include an annual sales growth

target of 5-8%, resulting in revenue of EUR1.7bn and EBITDA of over

EUR350m in 2022E.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY15 FY16 FY17 FY18 FY19

Key customer Keurig Zodiac Other China Indonesia

0

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3,500


RM m

10 October 2019


Page 35 of 54

Fig 38: Fluidra’s market share in the EEA post-merger with Zodiac

Country / Region Market share in robotic cleaner

EEA 30 - 40%

Sweden 60 - 70%

Greece 60 - 70%

Spain 50 - 60%

Czech Republic 40 - 50%

Belgium 40 - 50%

Cyprus 40 - 50%

Germany 40 - 50%

Romania 40 - 50%

The Netherlands 40 - 50%

Austria 30 - 40%

Italy 30 - 40%

France 30 - 40%

Hungary 30 - 40%

Bulgaria 30 - 40%

Portugal 20 - 30%

Luxembourg 20 - 30% Source: Fluidra, Affin Hwang

… offers opportunity for VS to tap on the enlarged Fluidra group

Notably, VS has received Supplier of the Year Award from Fluidra this year

for its outstanding quality with zero market rejection for the past 9 months.

With this, we believe that the group stands a high chance in gaining market

share from Fluidra’s existing contract manufacturer in Israel. While the

revenue contribution from Zodiac is relatively small at <10% of VS’

revenue, the merger offers opportunity for VS to secure new contracts from

the enlarged Fluidra group post-integration of the businesses. Based on

our sensitivity analysis, every RM100m in new contracts from Fluidra could

potentially increase the group’s core net profit by c.3-4% for FY20-22E.

Contributions from Keurig to recover marginally

Revenue from Keurig declined 22% yoy in FY18 due to the cessation of

production of coffee machine models that have reached the end of the

product lifecycle, while new replacement models only commenced

production towards the end of FY18. The contribution from Keurig

continued to decline by a quarter in FY19 due to the merger exercise

between Keurig Green Mountain and Dr Pepper Snapple Group, which

required the company to work on aligning and integrating the businesses.

Going forward, we expect a marginal growth in contributions from Keurig

underpinned by organic sales growth on the back of the launching of more

functional new models and the escalating trade diversion.

#3. Turning risk into opportunity

Anticipating lower PCB assembly sales from its key customer...

VS is one of the earliest EMS players which had in-house printed circuit

board (PCB) assembly and battery pack assembly lines among its key

customer’s contract manufacturers, and hence has been supplying PCB

and battery packs to its key customer’s other contract manufacturers that

do not have the capability. However, as its key customer has indicated its

preference for all the contract manufacturers to have their own in-house

PCB assembly and battery pack assembly capabilities to realise cost

savings, most of its peers have jumped on the bandwagon to start a PCB

10 October 2019


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assembly and battery pack assembly segment in-house with a target to

achieve self-sufficiency. In view of this, VS has in fact anticipated

weakness in revenue from its PCB assembly and battery pack assembly

business segment since 2-3 years ago.

… but managed to secure a new customer to partly offset the

anticipated weakness

While its revenue from PCB assembly and battery pack assembly are still

holding up well year to date (contrary to earlier anticipation of weaker PCB

assembly and battery pack assembly sales), VS has recently secured a

new customer for its PCB assembly business with an estimated

contribution of RM200m per annum. While management remained tight-

lipped on the name of the customer and type of the product, it indicated

that the PCB assembly for this new customer has begun in August 2019

and the contract is to cater for two models of the customer’s commercial

products. In fact, this customer has its own existing PCB assembly lines,

and the new contract awarded to VS is a result of growing demand as the

customer has no intention to expand its own in-house PCB assembly

capacity. Note that PCB assembly business generates higher margins,

which should help to partly mitigate weakness as a result of the decline in

order flow from its key customer.

Fig 39: VS’ EMS solutions


#4. Streamlining regional operations

China: Having presence in China via 43.3%-owned subsidiary

VSI has a presence in China, via its 43.3%-owned subsidiary VS

International Group Ltd (VSIG). VSIG commenced its business in 1997 in

China, and was listed on the Main Board of the Hong Kong Stock

Exchange (HKSE) in 2002. Similar to its parent, VSIG is principally

engaged in the manufacture and sale of plastic molded products and parts,

assembling of electronic products as well as mould design and fabrication.

VSIG’s existing major customers include Georgia-Pacific, Amway and

Diamond. The key products VSIG manufactures include the Diamond

Water Bar, Aristo coffee machines, cutleries and paper cup dispensers.

A drag to the group’s performance since FY09

Having suffered in the past 8 years since FY09, VSIG turned around in

FY17 on the back of: i) new orders from NEP to serve NEP on an ODM

basis, offering one-stop EMS services following VS’ acquisition of a 20%-

stake in NEP, and ii) increase in orders from Perfect China to manufacture

a new air purifier model on an ODM basis for sale in the China market

(contract value: RMB400m or c.RM242m). However, the robust

performance in FY17 was short-lived as the results had fallen back into the

R&D

Plastic

Tooling

Design

Plastic

Tooling

Fabrication

Plastic

Injection

Molding

Plastic

Secondary

Processes

PCB

Assembly

Sub-

Assembly

Complete

Product

Assembly

Logistics &

Fulfillment

PCB

Assembly

Division

Plastic Injection DivisionTooling Division Assembly Division

4 key divisions in Manufacturing Services

10 October 2019


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red in FY18 and the losses further widened in 9MFY19, due to lower sales

orders from customers following the expiry of contract from its main

customer with no indication of contract renewal, which resulted in the

underutilisation of its facilities. Adding to the woes are the rising operating

cost structure and stiff competition in China.

Operations in China losses widened in FY19

VSIG’s revenue declined 44% yoy to RM388m in FY19, while pre-tax

losses almost quadrupled to RM83m (from RM22m pre-tax losses in FY18)

or RM36m excluding non-controlling interest, mainly due to the

underutilisation of its facilities and the significant downsizing activities.

Stripping off the exceptional items, the estimated core pre-tax losses stood

at RM45m, or RM19m excluding non-controlling interest (which was an

11% drag on the group’s pre-tax profit in FY19).

Stemming the losses

VS is in the midst of streamlining and downsizing its operations in China in

order to optimize costs and minimize losses. Following the recognition of

the sizeable restructuring costs, the group expects its China operation’s

core net losses to narrow on lower fixed overhead costs. It has no plan to

dispose its operations in China at this junction, and is currently pursuing an

asset-light strategy to lower gearing and improve financial flexibility for its

operation in China.

Outlook remains bleak

Going forward, the operating environment for its China operation is

expected to remain challenging due to the underutilization of its facilities on

the back of the absence of large sales orders as a result of intensive

competition and prolonged US-China trade tension. Moreover, we do not

rule of the possibility that its operation in China might record wider losses

should the US-China trade tension escalate into a full-blown trade war. Our

in-house economists see a 30% probability of a global recession in 2020E,

based on the assumption that US-China trade tension could escalate into a

full-blown trade war in the coming months.

Indonesia: Impacted by lower sales volume and weakening of Rupiah

VS also has a presence in Indonesia through its wholly-owned subsidiary,

PT. V.S. Technology Indonesia, which involves in printed circuit board

(PCB) assembly and sub-assembly. Revenue from its Indonesian

operations declined 19% yoy to RM246m (6% of the group’s revenue) in

FY19 due to lower sales volume coupled with the weakening of the

Indonesian Rupiah. As a result, FY19 pre-tax profit declined 58% to RM1m

(0.8% of the group’s pre-tax profit). On a positive note, its operation in

Indonesia has returned to the black since 2QFY19 after incurring losses for

three consecutive quarters, underpinned by favorable product mix.

To maintain at current scale as sub-assembly house

Management expects its operations in Indonesia to remain profitable,

though minimal to the group, as it continues to seek new business to attain

higher levels of economies of scale. The group plans to maintain its

Indonesian operations at current scale as a sub-assembly house given the

different business environment in Indonesia, where the customers usually

prefer to be their own main contractor, hence it is difficult to expand

Indonesian operations as compared to its main operations in Malaysia.

10 October 2019


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While its operation in Indonesia is also likely to benefit from the positive

spillover from trade diversion, its Indonesian operation was relatively small,

making up only 6-7% of the group’s revenue in FY18-19.

Fig 40: Segmental revenue track record


Fig 41: Segmental pre-tax profit track record


Fig 42: Segmental revenue breakdown (FY18)


Fig 43: Segmental revenue breakdown (FY19)


Fig 44: Quarterly pre-tax profit/loss from China operation


Fig 45: Quarterly pre-tax profit/loss from Indonesia operation


1,328 1,489

2,294

3,088 3,338

526

565

803

304 246

81 119

182

689 388

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(8) (19)

17 3 1

(4)

7

(5) (22)

(83)

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(100)

(50)

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RM m Malaysia China Indonesia

Malaysia, 76%

Indonesia, 7%

China, 17%

Malaysia, 84%

Indonesia, 6% China, 10%

(60.0)

(50.0)

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10 October 2019


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Financial Analysis and Forecasts

Strong revenue and core net profit growth in the past 5 years

VS recorded an encouraging 5-year revenue and core net profit CAGR of

18% and 23% respectively, through FY19, driven by growing orders from

its customers. The group had achieved a record-high revenue of RM4.1bn

in FY18 (+25% yoy), mainly driven by its single largest key customer.

However, despite stripping off the exceptional items related to impairment

loss on properties and loss on disposal of a subsidiary, FY18 core net

profit declined 11% yoy, mainly dragged by the set-up costs for new lines

and the losses from its China operations.

FY19 core net profit improved despite marginally lower revenue

Previously expected to be hit by the decline in order flow from its largest

key customer in FY19, VS’ FY19 performance came in above the market’s

expectation with revenue only declining 3% yoy while core net profit grew

11% yoy to RM166m in FY19, mainly due to the higher contribution from

Malaysian operations which offset the weakness in regional operations.

Malaysia continues to underpin growth

Despite a decline in order flow from its key customer, VS’ revenue from

Malaysia’s operation grew 8% yoy mainly due to the higher demand for the

key customer’s personal care products, which command higher ASP. PBT

for Malaysia’s operation also increased 34% yoy, mainly due to: i) the

improvement in production efficiency stemming from greater economies of

scale as more lines are running optimally, ii) the low base effect in FY18

which was affected by high initial set-up costs associated with

commissioning of new lines, and iii) more favorable product sales mix,

particularly the key customer’s personal care products which command

higher ASP.

4QFY19 results above market expectations

In term of quarterly performance, VS’ 4QFY19 results were a positive

surprise to the market. Revenue was flat (+0.3% yoy) as the strong growth

of domestic sales (+10% yoy) was offset by its China operation (-47% yoy).

In an effort to streamline its China operations, its China subsidiary

recognized one-off expenses including loss on disposal of plant and

equipment, impairment loss on plant and equipment and termination

benefit to employees, which amounted to RM35m. Stripping off the

exceptional items, VS’ core net profit grew 5% yoy on the back of improved

production efficiency, lower initial setup costs and more favorable product

sales mix.

Expecting 3-year core net profit CAGR of 8%

We expect VS to record 3-year core net profit CAGR of 8% over FY19-

22E, underpinned by: i) improvement in efficiency due to optimal running of

production lines, ii) potential more contract wins from its existing

customers, Bissell, and other potential new customers as a result of trade

diversion, and iii) potential narrowed losses from China due to the cost

rationalisation initiatives. While the orders from its key customer are

expected to be decline in FY20E due to the cessation of production of the

older floor-care model that has reached the end of the product lifecycle, we

expect this to be offset by Bissell and potential new customers.

10 October 2019


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Potential upside from further new contract wins

VS has secured Bissell, a new PCB assembly customer and another new

box-build customer which are expected to collectively contribute RM600m

or 15% to the group’s revenue in FY20E. We have not included any further

potential additional contract wins from new customers, hence any further

potential contract wins from new customers as a result of US-China trade

tension would provide upside to our earnings forecast. Based on our

sensitivity analysis, every RM100m of revenue from a new contract from a

new customer could potentially increase the group’s core net profit by c.2-

3% for FY20-22E.

Fig 46: Projecting 6% 3-year revenue CAGR (FY19-22E)


Fig 47: Projecting 8% 3-year core net profit CAGR (FY19-22E)


Healthy financial position

VS sits on a healthy cash pile of RM379m as at end-FY19 and generates

consistent strong net operating cash flow annually with an average net

cash generation from operations of around RM142m per year over the past

five years. The group has spent significant capex of RM167m/RM217m/

RM125m in FY17/FY18/FY19, mainly to acquire new facilities and

production lines for expansion. Following the expansion, management

expects its capex to normalize to around RM60m per year over the next

three years. Its current net gearing is comfortable at 0.03x (as at end-

FY19), which allows it to leverage to fund growth, if necessary.

Distributes dividend every quarter

VS has a formal dividend policy of paying out at least 40% of its net profit

to reward investors. The group has consistently paid out an average 45%

of its net profit as dividends over the last 10 years. For FY20-22E, we

estimate a dividend payout of 40%, translating to an average yield of

around 3-4%.

-10%

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FY15A FY16A FY17A FY18A FY19A FY20E FY21E FY22E


0.0%

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2.0%

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6.0%

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0

50

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250

FY15A FY16A FY17A FY18A FY19A FY20E FY21E FY22E


10 October 2019


Page 41 of 54

Fig 58: 10-year dividend track record


Valuation and Recommendation


We initiate coverage on VS with a BUY rating and 12-month TP of

RM1.60. Our TP is based on 16x CY20E PER, which based on +0.5SD of

its 5-year forward PER mean given the group’s strong ability in securing

new customers. Though this is above its 10-year forward PER mean of 9x,

we think the premium valuation to its 10-year PER mean is justified as the

group has grown into a much larger corporation with a diversified customer

base and strong track record over the years, recording 10-year revenue

and core net profit CAGRs of 19% and 33% respectively. We like VS for

its: 1) diversified customer mix, 2) strong ability in securing new contracts

which makes it a prime beneficiary of trade diversion, 3) earnings growth on

the back of new orders and potential narrowed losses from its China

operations, and 4) reasonable dividend yields of 3-4%. Trading at only 13x

PER to its CY20E EPS, we think that the valuation looks appealing at

current levels.

Operations still resilient despite expectations falling through

Despite the reduction in orders from its key customer which disappointed

the market, VS has managed to secure new customers to partly fill the gap

within a remarkably short period. With the recent contract wins

demonstrating its strong ability in clinching new contracts, we believe that

VS is at the forefront of securing more orders from the trade diversion. In

addition, its recent quarters results were above market expectations due to

the improved production efficiency arising from greater economies of

scale, the absence of set-up costs of new lines and more favourable

product mix. While we remain cautious on the potential risks for its China

operations on the back of the prolonged trade tension, the losses should

moderate going forward following the downsizing activities in FY19.

0%

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90%

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FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

RM m Dividend paid (LHS) Dividend payout (RHS)

10 October 2019


Page 42 of 54

Fig 49: VS’ 5-year forward PER


Fig 50: VS’ 10-year forward PER





Downside risks include: i) dependent on single major customer; ii) reliance

on foreign labor, iii) competition risk, iv) a prolonged US-China trade

standoff, and v) a slowdown in the economy.

-

5.0

10.0

15.0

20.0

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Oct1

4

Dec14

Fe

b15

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5

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Aug

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(x)

+2 SD: 23.7x

+1SD: 18.4x

Avg: 13.1x

-1SD: 7.8x

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(x)

+2 SD: 20.2x

+1SD: 14.7x

Avg: 9.1x

-1SD: 3.6x



ATA IMS* BUY 1.45 1.80 24.1 1,746.3 14.3 12.9 14.8 10.6 24.9 8.9 8.7 7.6 2.5 2.2 19.0 2.5

V.S. Industry* BUY 1.26 1.60 27.0 2,314.0 13.8 12.6 8.9 9.5 (2.0) 6.0 7.5 6.4 1.4 1.3 10.8 3.4



Average 13.6 11.8 3.4 15.5 7.6 9.7 7.3 6.3 1.8 1.7 14.0 3.5




Average 14.2 11.9 77.7 17.9 29.6 6.4 14.0 11.2 n/a 2.7 19.7 n/a


10 October 2019


Page 43 of 54

Company background

The largest home-grown EMS provider in Malaysia

VS Industry was established in Singapore in 1979 and subsequently

relocated to Malaysia in 1982. The group was listed on the Main Market of

Bursa Malaysia in 1998. Based in Johor, VS is a leading global EMS

provider involved in plastic injection moulding, mould design and

fabrication, production of PCB assembly, sub-assembly and final product

assembly of consumer electronic products. VS serves as original design

manufacturer (ODM) and original equipment manufacturer (OEM) to

customers who are mainly from the USA, Europe and Japan. VS is not

only Malaysia’s largest home-grown EMS provider but it is also one of the

world’s top 50 EMS providers (ranked 23rd in 2018) and top 5 EMS

providers in ASEAN.

Fig 52: Major milestones

Year Achievements & Awards

1979 Established in Singapore

1982 Relocated to Malaysia

1997 Expanded into China

1998 Listed on Bursa Malaysia

2001 Secured the key customer as customer

2002 VS International Group Ltd (VSIG), listed on HKSE

2003 Expanded into Indonesia

2011 Annual revenue hit RM1.0bn

2012 Secured Keurig as customer

2013 Secured Zodiac as customer

Acquired additional stake in VSIG, making it a subsidiary of the group

2014 R&D award by the key customer

2015 CSR award by the key customer

2016 Acquired 20%-stake in NEP ((Diamond water filters)

Annual revenue crossed RM2.0bn

Commenced box-build assembly for floor care products

Lean Manufacturing Award by the key customer

Vertically Integrated Status Award by the key customer

Best Supplier Award by Keurig

2017 Acquired 60%-stake in Skreen Fabric

Achieved record high revenue & net profit (RM3.3bn & RM156.3m)

“Brew A Better World” recognition by Keurig

“Supplier of the Year” award by Keurig

2018 Acquired remaining 40%-stake in Skreen Fabric

Annual revenue hit record high of RM4.1bn

2019 Secured Bissell as customer

Supplier of the Year award by Fluidra


Proven track record of delivering a wide range of products

Headquartered in Johor, VS has more than 30 years of experience and

track record. Examples of finished and semi-finished products

manufactured and/or assembled by the group include floor care products,

coffee brewers, automatic swimming pool cleaners, automotive plastic

components, printed circuit boards, and battery packs, etc. The group has

manufacturing facilities in Malaysia, China and Indonesia, with a total

combined built-up space of more than 3m sq. ft.

10 October 2019


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Fig 53: Distinctive clientele base

*Unable to disclose actual name due to the companies’ commercial arrangement with the key customer Source: Company

Fig 54: Products manufactured and/or assembled


Fig 55: Regional presence in Malaysia, Indonesia and China


Experienced management team

VS is helmed by the founding members of the group – Datuk Beh Kim Ling

(Executive Chairman) and Datuk Gan Sem Yam (Managing Director), who

have over 30 years of experience in plastics injection. Both of them and

their family members own 19% and 6% in the group respectively.

10 October 2019


Page 45 of 54

Fig 56: Experienced management team with strong industry expertise Key Management Personnel Profile

Datuk Beh Kim Ling Aged 61, Malaysian Executive Chairman

Has more than 30 years of contract manufacturing experience in the plastic injection and electronics & electrical assembly industries Started his career in 1976 as a plastic injection moulding technician in Singapore Set up V.S. Industry Pte. Ltd. in Singapore in 1979 Relocated the entire business operations from Singapore to Johor Bahru, and together with his wife, Datin Gan Chu Cheng, incorporated V.S. Industry Berhad in 1982 Brother-in-law to Datuk Gan Sem Yam and Dato’ Gan Tiong Sia

Datuk Gan Sem Yam Aged 63, Malaysian Managing Director

Joined V.S. Industry in 1982 and played the key role in setting up the plastic finishing and electronic assemblies division Promoted to General Manager and appointed as an Executive Director in 1988 Instrumental in the business integration and expansion of the Group since 1990 Brother to Datin Gan Chu Cheng & Dato’ Gan Tiong Sia Brother-in-law to Datuk Beh Kim Ling

Datin Gan Chu Cheng Aged 65, Malaysian Executive Director

Has more than 20 years of enterprise building experience and played a key role in the Group’s expansion, both locally and overseas Established V.S. Industry Berhad together with her husband in 1982 Spouse of Datuk Beh Kim Ling Sister to Datuk Gan Sem Yam & Dato’ Gan Tiong Sia

Dato’ Gan Tiong Sia Aged 59, Malaysian Executive Director

Joined V.S. Industry in 1982 as a Management Trainee and was promoted to Marketing Manager in 1986 Appointed to the Board in 1988 Responsible for the overall marketing function of the group Brother to Datin Gan Chu Cheng & Datuk Gan Sem Yam Brother-in-law to Datuk Beh Kim Ling

Ng Yong Kang Aged 58, Malaysian Executive Director

Has extensive engineering and operations experience in the manufacturing sector, with MNCs like General Electric (TV) Sdn. Bhd., Thomson Audio Muar Sdn.Bhd., Lion Plastic Industry Sdn. Bhd. and Likom Group of Companies Joined V.S. Industry as a Group General Manager in 2002 Joined the Board in 2005 Graduated from the National Taiwan University with a Bachelor of Science in Mechanical Engineering in 1985, obtained a Diploma in Management from the Malaysian Institute of Management in 1992, and has a Master in Business Administration from the Heriot-Watt University, UK in 2002


10 October 2019


Page 46 of 54

V.S. Industry – FINANCIAL SUMMARY


Profit & Loss Statement Key Financial Ratios and Margins

FYE 31 Jul (RM m) 2018A 2019A 2020E 2021E 2022E FYE 31 Jul (RM m) 2018A 2019A 2020E 2021E 2022E

Revenue 4,101 3,978 4,042 4,345 4,678 Growth

Operating expenses -3,815 -3,684 -3,714 -3,988 -4,292 Revenue (%) 25.0 -3.0 1.6 7.5 7.7

EBITDA 285 294 328 358 386 EBITDA (%) -10.6 3.1 11.5 9.0 7.9

Depreciation -79 -99 -87 -90 -93 Core net profit (%) -11.2 10.7 5.3 10.4 9.7

EBIT 206 195 241 267 293

Net int income/(expense) -23 -19 -14 -10 -7 Profitability

Exceptional gains / (losses) -1 8 0 0 0 EBITDA margin (%) 7.0 7.4 8.1 8.2 8.3

Associates' contribution -7 -2 3 2 2 PBT margin (%) 4.3 4.6 5.7 6.0 6.1

Pretax profit 175 182 229 260 288 Net profit margin (%) 3.7 4.2 4.3 4.4 4.5

Tax -39 -62 -69 -75 -81 Effective tax rate (%) 22.1 34.2 30.0 29.0 28.0

Minority interest 14 46 14 9 5 ROA (%) 5.0 5.4 5.7 6.2 6.6

Net profit 150 166 175 193 212 ROE (%) 12.0 10.9 10.6 11.0 11.4

Core net profit 150 166 175 193 212 ROCE (%) 10.7 9.5 11.8 12.8 13.6

Dividend payout ratio (%) 45.8 45.8 50.8 45.0 45.0

Balance Sheet Statement

FYE 31 Jul (RM m) 2018A 2019A 2020E 2021E 2022E Liquidity

Fixed assets 873 889 862 831 798 Current ratio (x) 1.5 1.7 1.9 2.0 2.1

Other long term assets 314 236 238 240 242 Op. cash f low (RM m) 215 226 264 225 247

Total non-current assets 1,187 1,125 1,100 1,072 1,040 Free cashflow (RM m) 9 101 204 165 187

Cash and equivalents 416 379 443 472 513 FCF/share (sen) 0.5 5.5 11.2 9.1 10.3

Stocks 395 372 385 412 442

Debtors 940 1,014 993 1,067 1,149 Asset management

Other current assets 186 143 143 143 143 Debtors turnover (days) 83.6 93.1 89.6 89.6 89.6

Total current assets 1,936 1,908 1,963 2,093 2,247 Stock turnover (days) 37.8 36.8 37.8 37.7 37.6

Creditors 730 721 732 786 846 Creditors turnover (days) 69.8 71.5 71.9 71.9 71.9

Short term borrow ings 552 362 300 250 200

Other current liabilities 14 21 21 21 21 Capital structure

Total current liabilities 1,295 1,104 1,053 1,057 1,067 Net gearing (%) 16% 3% -5% -9% -13%

Long term borrow ings 94 67 67 67 67 Interest cover (x) 12.3 15.5 23.5 36.7 57.0

Other long term liabilities 73 85 85 85 85

Total long term liab. 167 152 152 152 152

Shareholders' Funds 1,438 1,599 1,695 1,801 1,917 Quarterly Profit & Loss

Minority Interest 223 178 164 155 151 FYE 31 Jul (RM m) 4Q18 1Q19 2Q19 3Q19 4Q19

Revenue 1,027 1,076 983 890 1,030

Cash Flow Statement Operating expenses -963 -1,003 -906 -825 -950

FYE 31 Jul (RM m) 2018A 2019A 2020E 2021E 2022E EBITDA 64 73 77 64 80

Pretax Profit 176 174 229 260 288 Depreciation & amortization -21 -23 -23 -24 -29

Depreciation & amortisation 79 99 87 90 93 EBIT 43 50 54 41 51

Working capital changes -65 -66 19 -48 -52 Int expense -5 -6 -6 -4 -3

Cash tax paid -46 -52 -69 -75 -81 Associates' contribution -7 2 2 2 -7

Others 71 71 -3 -2 -2 Exceptional items 16 12 -6 -9 12

C/F from operation 215 226 264 225 247 Pretax profit 30 45 49 38 41

Capex -207 -125 -60 -60 -60 Tax -3 -17 -14 -12 -20

Others 22 15 0 0 0 Minority interest 14 11 2 5 27

C/F from investing -184 -110 -60 -60 -60 Net profit 42 40 38 31 48

Debt raised/(repaid) -51 -243 -62 -50 -50 Core net profit 58 51 32 22 61

Dividends paid -73 -72 -79 -87 -95

Others 220 151 0 0 0 Margins (%)

C/F from financing 96 -164 -140 -137 -145 EBITDA 6.2 6.8 7.8 7.2 7.8

Net change in cash flow 126 -48 64 28 42 PBT 3.0 4.2 5.0 4.3 4.0

Net profit 4.1 3.7 3.9 3.5 4.7

Free Cash Flow 9 101 204 165 187

10 October 2019


Page 47 of 54

The third largest local EMS player in Malaysia

Established in 1994, SKP Resources (SKP) is an Electronics

Manufacturing Services (EMS) provider, principally involved in the

manufacture of plastic components, precision moulds, advance

secondary processes, sub-assembly of electronics equipment and full

turn-key contract manufacturing. SKP serves a common key customer

as ATA IMS and V.S. Industry, which accounts for over 70% of its

revenue. Going forward, SKP plans to expand its PCB assembly,

injection moulding and engineering capabilities in anticipation of

higher capacity utilisation and to improve production throughput.

First in-house PCB assembly line commenced in April 2019

SKP commenced its first in-house printed circuit board (PCB) assembly line

in April 2019, which is expected to improve its profitability and success rate

in clinching new orders from its key customer given the latter’s emphasis for

its contract manufacturers to be vertically integrated.

Weak performance in recent quarter

SKP recorded weaker performance in the recent quarter with 1QFY20

revenue slipping 16% yoy due to moderating demand by its key customer for

production of an older model that has progressed towards the later part of

the product lifecycle. Consequently, core net profit declined 31% yoy given

the reduction in orders, higher operating expenses and diminished

economies of scale due to the production volume drop.

On expansion mode

Nevertheless, SKP recorded a 5-year revenue and core net profit CAGR of

32% and 28% respectively, mainly driven by the strong orders from its key

customer. The group has set aside a higher capex of RM47m for FY20E to

expand its PCB assembly, injection moulding and engineering capabilities in

anticipation of higher capacity utilisation and improved production throughput

as per its key customer guidance (FY17-19: RM24-26m).

In a healthy financial position

SKP is the only net cash company among its closest peers, sitting on a net

cash position of RM257m (RM0.21/share, which represent 19% of its current

market capitalisation). The group has been consistently distributing 50% of

its profit as dividend, which is in line with its dividend payout policy.

Valuation below that of its local peers

SKP’s CY18 historical PER of 13x is below the 14x average PER of its local

peers and the local listed companies that are part of “D” ecosystem.


FYE 31 Mar 2015A 2016A 2017A 2018A 2019A

Revenue (RMm) 619.3 1,015.4 1,943.6 2,106.4 1,654.2

EBITDA (RMm) 64.3 121.6 158.8 173.7 139.0


Net profit (RMm) 42.3 81.5 103.3 126.8 96.7

EPS (sen) 3.4 6.5 8.3 10.1 7.7

PER (x) 31.9 16.6 13.1 10.7 14.0


Core EPS (sen) 3.4 6.1 8.4 9.4 7.6

Core EPS growth (%) 54.7 80.9 37.5 11.7 (19.0)

Core PER (x) 32.0 17.7 12.9 11.5 14.2

Net DPS (sen) 2.0 3.5 4.2 5.1 3.8

Dividend Yield (%) 1.8 3.2 3.8 4.7 3.6

EV/EBITDA (x) 19.8 11.2 8.7 7.4 9.4 Source: Company, Bloomberg, Affin Hwang forecasts

Company Note

SKP Resources SKP MK Sector: EMS

RM1.08 @ 9 October 2019

Non-rated

Price Target: n/a Previous Target: n/a

Price Performance

1M 3M 12M Absolute 1.9% -15.0% -15.0% Rel to KLCI 5.4% -7.7% -2.7%

Stock Data

Issued shares (m) 1,250.2 Mkt cap (RMm)/(US$m) 1350.2/321.7 Avg daily vol - 3mth (m) 0.9 52-wk range (RM) 0.95-1.44 Est free float 56.0% BV per share (RM) 0.48 P/BV (x) 2.23 Net cash/(debt) (RMm)

(3Q17)

257.49 Derivatives No Shariah Compliant Yes

Key Shareholders

Beyond Imagination Sdn Bhd 14.4% KWAP 14.4% Datuk Gan Kim Huat 9.5% Renown Million Sdn Bhd 8.1% Source: Company, Bloomberg

Chua Yi Jing (603) 2146 7546

[email protected]

0.00

0.50

1.00

1.50

2.00

2.50

Oct-16 Feb-17 Jun-17 Oct-17 Feb-18 Jun-18 Oct-18 Feb-19 Jun-19

(RM)

10 October 2019


Page 48 of 54

Focus charts Fig 57: Recorded 10-year revenue CAGR of 25%


Fig 58: Recorded 10-year core net profit CAGR of 28%


Fig 59: SKP’s distinctive clientele base

Source: Company

Fig 60: SKP’s key milestones


Fig 61: SKP 5-year forward PER


Fig 62: SKP 10-year forward PER


-40%

-20%

0%

20%

40%

60%

80%

100%

-

500.0

1,000.0

1,500.0

2,000.0

2,500.0



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0



Year

2000 Incorporated in Malaysia under the name of Vital Conglomerate Sdn Bhd

Converted to a public limited company

2002 Renamed to SKP Resources Bhd

Acquired the entire stake in Sin Hw ang Plastic Sdn Bhd, Goodhart Industries

Sdn Bhd and Goodhart Land Sdn Bhd

2003 Listed on the Second Board of KLSE

2004 Completed a share split exercise on the basis of 10 new ordinary shares for

every 1 ordinary share, 1-for-4 bonus issue and transfer of listing to the Main

Board of Bursa Malaysia

2005 Acquired the remaining 37%-stake in Goodhart Technology Sdn Bhd

2006 Acquired the entire stake in S.P.I Plastic Industries Sdn Bhd for RM30m

2009 Entered into a contract for manufacturing and supply of product w ith its key

customer

2012 Undertaken 1-for-2 bonus issue and 1-for-5 free w arrants

2015

Acquired entire stake in Plastictecnic (M) Sdn Bhd, Sun Tong Seng Mould-Tech

Sdn Bhd and Bangi Plastic Sdn Bhd, all w holly-ow ned subsidiaries of Tecnic

Group Berhad, for RM200m

-

5.0

10.0

15.0

20.0

25.0

30.0

Oct1

4

Dec14

Fe

b15

Apr1

5

Jun1

5

Aug

15

Oct1

5

Dec15

Fe

b16

Apr1

6

Jun1

6

Aug

16

Oct1

6

Dec16

Fe

b17

Apr1

7

Jun1

7

Aug

17

Oct1

7

Dec17

Fe

b18

Apr1

8

Jun1

8

Aug

18

Oct1

8

Dec18

Fe

b19

Apr1

9

Jun1

9

Aug

19

Oct1

9

(x)

+2 SD: 22.7x

+1SD: 19x

Avg: 15.3x

-1SD: 11.6x

-2 SD: 7.9x

-

5.0

10.0

15.0

20.0

25.0

30.0

Oct0

9

Fe

b10

Jun1

0

Oct1

0

Fe

b11

Jun1

1

Oct1

1

Fe

b12

Jun1

2

Oct1

2

Fe

b13

Jun1

3

Oct1

3

Fe

b14

Jun1

4

Oct1

4

Fe

b15

Jun1

5

Oct1

5

Fe

b16

Jun1

6

Oct1

6

Fe

b17

Jun1

7

Oct1

7

Fe

b18

Jun1

8

Oct1

8

Fe

b19

Jun1

9

Oct1

9

(x)

+2 SD: 21.7x

+1SD: 16.4x

Avg: 11.1x

-1SD: 5.8x

-2 SD: 0.5x

10 October 2019


Page 49 of 54

Specialised automation machines expert

i-Stone is principally involved in the design, manufacturing and

modification of specialised automation machines (c.72% of its revenue

in FY18), maintenance & technical support services, and provision of

data management systems (DMS). It serves the same common key

customer as the EMS players, which accounted for 65% of its revenue

in FY18, and has been working with the key customer for the past 12

years since its incorporation in 2007. Going forward, i-Stone plans to

focus on: i) developing new products and new features for its existing

machines, ii) enhancing its manufacturing and design and

development capabilities, and iii) improving its manufacturing

efficiency with standard modules.

Experienced management team with strong industry expertise

i-Stone is led by an experienced management team, each with >15 years of

experience in the E&E industry specializing in specialized automation

machines, and has a diversified customer base of >100 customers from

various industries, i.e, E&E (household appliances & consumer electronics),

automotive, robotics, mechanical & engineering, and semiconductors.

3-year revenue and core net profit CAGR of 15% and 22% respectively

i-Stone recorded 3-year revenue and core net profit CAGR of 15% and 22%

respectively, through 2018, mainly driven by: i) the increase in sales of

various new customised specialised automation machines, which is in line

with the increase in manufacturing lines set up for new models introduced by

its key customer, and ii) the attainment of economies of scale.

Paving the way for industry 4.0

i-Stone relocated its manufacturing operations to its new factory in October

2018. With the additional floor space, it plans to: i) acquire new machines,

equipment and software to enhance its manufacturing capability, and ii)

improve its efficiency by manufacturing standard modules. In addition, it

plans to build a new design and development (D&D) centre within the

compound of the new factory to expand its product offerings and ongoing

design activities, with target completion in 2H2021. Besides, it will also focus

on the development of new products and features for its existing machines

(i.e., deep learning system for vision inspection machines, fully-automated

joint-test system and more advanced version of DMS).

Valuation in between that of its indirect and direct local peers

i-Stone’s CY18 historical PER of 19x is above the 14x average PER of the

local listed companies that are part of “D” ecosystem, but below its listed

local peers’ average PER of 25x. i-Stone was listed on the ACE Market on

17 July 2019 at an IPO price of RM0.16.


FYE 31 Dec 2014A 2015A 2016A 2017A 2018A

Revenue (RMm) - 44.1 43.1 60.4 67.6

EBITDA (RMm) - 4.8 5.8 9.9 13.1

Pretax profit (RMm) - 4.5 5.1 9.4 12.0

Net profit (RMm) - 4.0 4.7 8.2 11.2

EPS (sen) - 0.3 0.4 0.7 0.9

PER (x) - 54.8 46.3 26.8 19.5

Core net profit (RMm) - 6.3 4.7 9.8 11.5

Core EPS (sen) - 0.5 0.4 0.8 0.9

Core EPS growth (%) - n/a (25.8) 107.1 17.6

Core PER (x) - 34.7 46.7 22.6 19.2

EV/EBITDA (x) - n/a n/a n/a n/a Source: Company, Bloomberg, Affin Hwang forecasts

Company Note

i-Stone Group ISTONE MK Sector: Technology

RM0.18 @ 9 October 2019

Non-rated


Price Performance

1M 3M 12M Absolute 8.8% n/a n/a Rel to KLCI 12.6% n/a n/a

Stock Data

Issued shares (m) 1,221.5 Mkt cap (RMm)/(US$m) 226/53.8 Avg daily vol - 3mth (m) 11.9 52-wk range (RM) 0.15-0.28 Est free float 66.8% BV per share (RM) 0.03 P/BV (x) 6.65 Net cash/(debt) (RMm)

(3Q17)

(12.11) Derivatives No Shariah Compliant Yes

Key Shareholders

One United Equity Sdn. Bhd. 27.0% Chan Kok San 20.3% Chin Chung Lek 7.4% Tee Sook Sing 5.5% Source: Company, Bloomberg

Chua Yi Jing (603) 2146 7546

[email protected]

0.00

0.05

0.10

0.15

0.20

0.25

0.30

16-Jul-19 30-Jul-19 13-Aug-19 27-Aug-19 10-Sep-19 24-Sep-19 8-Oct-19

(RM)

10 October 2019


Page 50 of 54

Focus charts Fig 63: Business segments

Source: Company

Fig 64: Manufacturing capabilities – Design, manufacturing &

modification of specialised automation machines

Source: Company

Fig 65: Complementary product & services – Design &

fabrication of precision machining parts, metal frames &

panels

Source: Company

Fig 66: Core net profit track record


Fig 67: Revenue breakdown by business


Fig 68: Major milestones


6.3

4.7

9.8

11.514.4%

10.9%

16.1% 17.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2015 2016 2017 2018


Business Segments (%) 2015 2016 2017 2018

Manufacturing automation 81.8% 80.0% 81.9% 83.6%

(1) Design, manufacturing &

modification68.9% 64.7% 65.5% 71.8%

(2) Maintenance & technical

support services10.7% 12.7% 12.6% 9.6%

(3) Provision of Data

Management Systems2.2% 2.6% 3.8% 2.2%

Complementary products &

services18.2% 20.0% 18.1% 16.4%

(4) Design & fabrication of

metal panels, frames &

precision parts

0.0% 1.7% 4.2% 4.0%

(5) Distribution of

manufacturing automation

hardware & software

18.2% 18.3% 13.9% 12.4%

Year

2007 Establishment of i-Stone Technology Sdn Bhd at Skudai Johor, Malaysia

Commenced the assembly & modification of specialised automation machines

& provision of Data Management Systems

2010 Set up in-house mechanical engineering team to develop mechanical designs

for the specialised automation machines

2011 Ventured into distribution of manufacturing automation softw are & hardw are,

namely Minitab & Digi

2013 Ventured into the design & fabrication of precision parts used in specialised

automation machines via the acquisition of 40.0% equity interest in i-Stone

Engineering

2016 Expanded in-house capability to include the design & fabrication of metal

panels & frames used for specialised automation machines via the acquisition

of the 60.0% equity interest P.A. Metal

2018 Distribute robotic arms from Universal Robots A/S in Malaysia

Moved to centralised manufacturing facility in Taman Teknologi Johor, Senai to

accommodate to its grow th in business activities

10 October 2019


Page 51 of 54

Label printing & material converting specialist

MTAG is involved in the: i) printing of labels & stickers and customised

converting services, and ii) distribution of industrial tapes, adhesives &

other products. MTAG is understood to be one of the largest label &

sticker suppliers and converters of mesh materials for its indirect key

customer – a global renowned household appliances brand. It is also an

authorised distributor for 3M and Henkel’s industrial tapes and

adhesive products. MTAG plans to construct a new manufacturing

plant and purchase new machineries to increase its capacity for the

printing of labels and stickers gradually over the next 3 years.

Established track record & relationship with reputable customers

MTAG has been in operation for >23 years and has established a diversified

customer base of >600 customers from various industries such as electrical

& electronic (E&E), precision tooling, mechanical & engineering, automotive

and construction. Approximately 80% of MTAG’s revenue is contributed by

the EMS companies, namely ATA IMS, V.S. Industry and SKP Resources,

who are serving a common key customer. As part of the “D” value chain,

MTAG supplies certain components of household appliances such as mesh,

labels and stickers, tapes and adhesives, which are used by its customers to

assemble products for its indirect key customer.

3-year revenue and core net profit CAGR of 14% and 28% respectively

MTAG recorded FY16-19 revenue and core net profit CAGR of 14% and

28% respectively, mainly driven by higher sales arising from the introduction

of new models by its indirect key customer and higher cost efficiency.

Printing & converting business was the main revenue contributor, accounting

for an average 86% of its revenue over the past 4 years, with the remaining

14% contributed by its distribution business. MTAG is sitting on a net cash

position of RM20m as at end-FY19 and has a 20% dividend payout policy.

Capacity expansion plan to cater for new job orders

MTAG intends to acquire a plot of 10-acre land to construct a new

manufacturing plant to house its corporate office, production lines and

warehouse in 2 phases. In addition, MTAG will purchase new machineries to

double its annual capacity for printing of labels & stickers (the segment which

contributed 21% to the group’s revenue in 9MFY19) over the next 3 years

and improve production efficiency.

Valuation below that of its indirect local peers

MTAG’s CY18 historical PER of 9x is below the 14x average PER of the

local listed companies that are part of “D” ecosystem. MTAG was listed on

the ACE Market on 25 September at an IPO price of RM0.53.


FYE 30 Jun 2015A 2016A 2017A 2018A 2019A

Revenue (RMm) - 127.0 186.6 187.5 190.0

EBITDA (RMm) - 24.5 34.6 61.9 46.4

Pretax profit (RMm) - 21.1 30.0 58.3 43.8

Net profit (RMm) - 15.9 22.6 47.5 33.0

EPS (sen) - 2.3 3.3 7.0 4.8

PER (x) - 18.0 12.6 6.0 8.7

Core net profit (RMm) - 15.9 22.6 34.5 33.0

Core EPS (sen) - 2.3 3.3 5.1 4.8

Core EPS growth (%) - n/a 42.4 52.4 (4.5)

Core PER (x) - 18.0 12.6 8.3 8.7

EV/EBITDA (x) - n/a n/a n/a n/a Source: Company, Bloomberg, Affin Hwang forecasts

Company Note

MTAG Group MTAG MK Sector: Label Printing & Converting

RM0.42 @ 9 October 2019

Non-rated


Price Performance

1M 3M 12M Absolute n/a n/a n/a Rel to KLCI n/a n/a n/a

Stock Data

Issued shares (m) 681.6 Mkt cap (RMm)/(US$m) 286.3/68.2 Avg daily vol - 3mth (m) 4.0 52-wk range (RM) 0.41-0.7 Est free float 29.8% BV per share (RM) 0.15 P/BV (x) 2.87 Net cash/(debt) (RMm)

(3Q17)

19.68 Derivatives No Shariah Compliant Yes

Key Shareholders

Chaw Kam Shiang 50.5% Lau Cher Liang 16.7% Ang Yam Fung 2.0% Source: Company, Bloomberg

Chua Yi Jing (603) 2146 7546

[email protected]

0.00

0.10

0.20

0.30

0.40

0.50

0.60

24-Sep-19 1-Oct-19 8-Oct-19

(RM)

10 October 2019


Page 52 of 54

Focus charts

Fig 69: Corporate structure

Source: Company

Fig 70: Business segments

Source: Company

Fig 71: Key milestones

Source: Company

Fig 72: Utilisation of IPO proceeds


Fig 73: Printed products

Source: Company

Fig 74: Converted products

Source: Company

Land acquisition & construction of

manufacturing plant, 46%

Capital expanditure, 18%

Repayment of bank borrow ings,

14%

Working capital, 17%

Estimated listing expenses, 5%

10 October 2019


Page 53 of 54

Fig 75: 3M’s industrial tape and adhesive products

Source: Company

Fig 76: Henkel’s adhesive products

Source: Company

Fig 77: Revenue breakdown by business segments


Fig 78: Revenue breakdown by major products


Fig 79: Printing & converting capacity

Source: Company

Fig 80: Malaysia label printing & converting industry is

projected to grow at a CAGR of 8.2%

Source: Independent Market Research conducted by Protégé Associates Sdn Bhd

FY16 FY17 FY18 9MFY19

Distribution 16.8 25.6 31.1 22.9

Printing & converting 110.2 161.0 156.4 167.1

86.8%

86.3% 83.4%88.0%

13.2%

13.7% 16.6%12.0%

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

RM m

127.0

186.6 187.5190.0

64% 62%57% 57%

13% 17%18% 21%

10% 7%8%

9%

13% 14% 17% 13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY16 FY17 FY18 9MFY19

Filter media & mesh Stickers & labels

Hardware products General merchandise goods

5.05.5

5.96.4

7.07.5

8.1

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

2017A 2018A 2109E 2020E 2021E 2022E 2023E

RM bn

10 October 2019


Page 54 of 54

Important Disclosures and Disclaimer

Equity Rating Structure and Definitions

BUY Total return is expected to exceed +10% over a 12-month period

HOLD Total return is expected to be between -5% and +10% over a 12-month period

SELL Total return is expected to be below -5% over a 12-month period

NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information

only and not as a recommendation

The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months.

OVERWEIGHT Industry, as defined by the analyst’s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months

NEUTRAL Industry, as defined by the analyst’s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months

UNDERWEIGHT Industry, as defined by the analyst’s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months

This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) (“the Company”) based on sources believed to be reliable and is not to be taken in substitution for the exercise of your judgment. You should obtain independent financial, legal, tax or such other professional advice, when making your independent appraisal, assessment, review and evaluation of the company/entity covered in this report, and the extent of the risk involved in doing so, before investing or participating in any of the securities or investment strategies or transactions discussed in this report. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (expressed or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, estimates, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel and the same are subject to change without notice. Reports issued by the Company, are prepared in accordance with the Company’s policies for managing conflicts of interest. Under no circumstances shall the Company, be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company its directors, its employees and their respective associates may have positions or financial interest in the securities mentioned therein. The Company, its directors, its employees and their respective associates may further act as market maker, may have assumed an underwriting commitment, deal with such securities, may also perform or seek to perform investment banking services, advisory and other services relating to the subject company/entity, and may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. The Company, its directors, its employees and their respective associates, may provide, or have provided in the past 12 months investment banking, corporate finance or other services and may receive, or may have received compensation for the services provided from the subject company/entity covered in this report. No part of the research analyst’s compensation or benefit was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Employees of the Company may serve as a board member of the subject company/entity covered in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. This report, or any portion thereof may not be reprinted, sold or redistributed without the written consent of the Company. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) A Participating Organisation of Bursa Malaysia Securities Berhad 22nd Floor, Menara Boustead, 69, Jalan Raja Chulan, 50200 Kuala Lumpur, Malaysia. T : + 603 2142 3700 F : + 603 2146 7630 [email protected] www.affinhwang.com

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