Report ID 6053890046892 Popularity 84 views 13 downloads 
Report Date Sep 2022 Product  
Company / Issuer VS Capital Management Sdn Bhd Sector Manufacturing - Others
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Rating action     
MARC Ratings has assigned a rating of AAIS(cg)  to funding vehicle VS Capital Management Sdn Bhd’s Islamic Medium-Term Notes (IMTN) programme of up to RM1.0 billion. The rating outlook is stable. The rating reflects the credit strength of VS Industry Berhad (VSI) on the basis of an unconditional and irrevocable corporate guarantee it will provide on the IMTN programme. VS Capital Management is a wholly-owned special purpose vehicle of VSI.

Proceeds from the initial issuance of about RM500.0 million under the programme will largely be utilised to refinance the group’s existing borrowings and to fund its capex (facility expansion). 

The rating reflects VSI’s well established operating track record and strong market position in the electronics manufacturing services (EMS) industry as well as its healthy balance sheet structure, characterised by low-to-moderate leverage and strong liquidity position. These factors are counterbalanced by a low operating margin that is inherent in EMS players, and in recent years by supply chain and labour-related issues.

VSI currently operates 13 plants with a focus on household electronic products; these plants are located on a combined built-up space of about 3.5 million sq ft, of which around 2.1 million sq ft is in Senai, Johor Bahru. Its steadily built operational track record since 1982 has underpinned its global market position, ranking 26th globally by revenue in 2021, from 31st in 2016, according to the Manufacturing Market Insider. It is also the sixth-largest player in the ASEAN region. The key factors behind VSI’s improving position in the EMS industry is its strength as a vertically integrated contract manufacturer and its ability to meet stringent manufacturing specifications as required by its international clients who have strong global reputations to maintain. The group’s ability to adjust its production scale to adhere to timelines and accommodate increased orders has also contributed to its growth. 

The aforementioned strengths notwithstanding, client concentration poses a risk to VSI given its top four clients accounted for about two-thirds of revenue for financial year ended July 31, 2021 (FY2021), in addition to the relative ease in which clients can switch manufacturers. To mitigate this risk, the group has undertaken initiatives to strengthen its relationships with  key clients and at the  same time has  aimed to broaden its clientele. MARC Ratings also views VSI’s longstanding experience in the EMS industry as a key factor enabling it to manage client relationships as well as undertake growth initiatives including tapping opportunities arising from the trade diversion to Malaysia due to US-China trade friction. 

Characteristic of EMS industry players, VSI’s operating profit margin has ranged in the single digits; nonetheless, its margin of about 6% in 9MFY2022 (except 8.42% in FY2021 due to a spillover effect from FY2020) is higher than those of many of its peers. Raw material cost, namely for resins (for plastic moulding) and stainless steel, constitutes a significant component of production cost, which stood at about 78% of RM3.5 billion in fiscal 2021. Raw material price volatility is addressed through its contracts under which price escalations can be passed through to the clients.

As with other manufacturing companies that are labour-intensive and to a certain extent are reliant on foreign workforce, VSI has had to contend with perceived shortcomings in their labour management policies. To address some of these issues, it has upgraded accommodation, settled recruitment fees on behalf of its workers and improved salaries. The group has also appointed PwC Consulting Associates (M) Sdn Bhd (PwC Consulting) in conducting an audit on its labour practices, the outcome of which has been released on July 6, 2022. We understand that there was no evidence of systemic forced labour practices identified by PwC Consulting. MARC Ratings notes that as a contract manufacturer of renowned brands, the group’s labour practices are audited by its clients periodically, and we understand that clients have been satisfied with VSI’s labour practices as at date. To reduce reliance on manual workers, the group is steadily implementing automation in its production lines to improve cost efficiency and productivity. We also note that VSI’s recent recruitment of a large number of foreign workers from Myanmar would substantially alleviate its labour shortage issue.

VSI recorded revenue of about RM4.0 billion for FY2018 onwards save FY2020 when it was impacted by pandemic-induced closures of its plants. Operating cash flow (CFO) has steadily increased over the years, except in FY2021 due to inventory payments. Its inventory build-up was increased to six months from three months previously, to manage supply chain issues. The cost for inventory build-up has led to negative free cash flow (FCF) of RM210 million in FY2021. VSI will revert to three months of inventory build-up when supply chain issues ease. 

Strong CFO generation, estimated at about RM200 million in FY2022, would be able to support its capex plans, of about RM150 million p.a. internally. Its cash balance of RM275.3 million and unutilised credit facilities of about RM80 million provide strong liquidity relative to its financial obligations. Group borrowings of RM562.8 million as at 9MFY2022 translated to a gross debt-to-equity (DE) ratio of 0.25x and net DE ratio of 0.14x.

Rating outlook     
The stable rating outlook reflects MARC Ratings’ expectation that VSI would broadly maintain its credit profile to be commensurate with the rating band over the next 12 months.

Rating trajectory    

Upside scenario     
Any upgrade would be guided by sustained improvement in business and financial performance, in particular maintaining a CFO-debt of about 0.5x–0.7x.

Downside scenario     
Downward rating pressure could occur if VSI’s performance were to deviate substantially from projections and/or if the group were to undertake aggressive debt-funded acquisitions and expansions that would affect its overall credit metrics. 

Key strengths
  • Key player in the global electronics manufacturing services (EMS) industry 
  • One-stop contract manufacturer
  • Strong cash flow generation
  • Low-to-moderate leverage position
Key risks
  • Low margin weighed down by competition and costs
  • Supply chain disruptions
  • Labour-related issues