• Downgrade to NEUTRAL from Buy, with new SGD14.40 TP from SGD18.26, 4% upside. Our downgrade is premised on disappointing 1H23 earnings from weak demand and lower operating margin, followed by a further FY23F-25F earnings cut of 9-11%. Although valuation is compelling, at -1SD of its historical mean, visibility of customer demand and earnings outlook remain weak. Given the soft outlook, we now peg our TP to 14x blended FY23-24F from 16x. Along with the earnings cut, our TP is reduced by a further 21%.

• 1H23 earnings below expectations. 1Q23 revenue of SGD1,582m (-12% YoY) and earnings of SGD140m (-20% YoY) were weaker than anticipated. Revenue disappointed on softer-than-expected demand and customer inventory destocking, as portfolios A and B declined by 15% and 9% YoY. While gross margin held stable at 25%, operating margin of 10.1% missed our 10.7% expectations due to higher energy costs and staff costs as a percentage of sales. Earnings as a result met 43% of our full year forecasts. Net cash however, grew from SGD2.78 to SGD3.08/share. An interim dividend of 25 SG cents amounting to a payout ratio of 52% was declared, in line with expectations.

• Cut FY23F-25F earnings by another 9-11%. As 1H23 trailed our full year estimates, we lower our FY24F-25F revenue by 9-10% while largely maintaining our margin assumptions, which result in a 9-11% earnings cut. FY24F-25F earnings are also lowered to 3-5% vs 5% previously.

• Anticipate soft near term outlook. VMS continued to miss our 1H23 estimates despite our earlier earnings cut, with the key driver being weak customer demand. 2H22 benefitted from strong customer pent up demand which eased in 1H23 as companies destocked their inventories. We do not envisage 2H23 to be exciting as companies continue to destock, which will continue to dampen VMS’s revenue. Our FY24F earnings are only 3%, if customer demand recovers, but FY24F would have further downside risks if demand does not. Growth drivers would stem from: i) New customer wins from de-risking its manufacturing base from higher risk Asian countries into South-East Asia; ii) technological demand for products in new segments such as the life sciences and electric vehicle or EV market; iii) improving value capture and margins via strong engineering and design capabilities; iv) new product introduction. Its balance sheet remains strong with higher net cash of SGD3.08/share. VMS declares dividends based on a sustainable DPS (75 SG cents for the past three years) – we believe it is well supported by its balance sheet and has minimal downside.

• Risks to our forecasts include earnings upside on a stronger and/or earlier-than-expected global recovery, and accelerating global demand. The converse represents the downside risks. We also apply a 0% discount/premium to its intrinsic value to derive our TP.

Source: RHB Research - 8 Aug 2023