Investment Highlights

• We are NEUTRAL on the auto sector with a projection of 2.0% TIV growth to 600K units in 2019 (from FY18F: 2-3% to 588K- 594K). A slate of new models that coincide with the pre-Chinese New Year buying will generate excitement at the beginning of the year in an otherwise mellow market. We identify the three key items to monitor in the year ahead:

1) Margin-oriented SUVs to lead a sea change in national players. Both national carmakers will launch their first SUVs with different priorities. Perodua will focus on sales while Proton will focus on improving the consumer perception. Proton will rely on the SUV to test the various operational reforms and processes that are being introduced to win back consumer confidence. We believe that the X70 requires a strong success story in the home market before expanding regionally. Perodua will follow suit and target the more affluent segment where the financing options are said to be more secure. Both players are looking to position themselves on more formidable ground by reducing their dependence on volume over time.

2) No time to wait and see. Our house projects the USD/MYR rate to be 4.12 and the OPR rate to be retained at 3.25% for next year. The weakening ringgit presents an immediate challenge to the margins of UMW Toyota, Tan Chong Motor and Pecca Group. These three companies have a relatively higher exposure to the. We believe automakers will need to time their launches of new models well to capture higher sales and place priorities on sales of better margin vehicles. This is to mitigate any margin erosions from the weaker ringgit and prevent a repeat of the situation in 2016-2017. To this end, UMW has lined up the Toyota Vios to push their sales volume at the open of the year. This will be followed by Toyota Yaris (by end-1H), an affordable hatchback that will also be assembled at its new plant in Shah Alam. For Pecca, we expect its automotive leather prices to remain stable. As for Tan Chong, the group may launch new Nissan models next year. It will retain its priority to focus on margins rather than volume while actively managing its inventory and debt levels. Other launches to keep an eye on include the Mazda CX-8 and Mazda 3 scheduled to come later in the year.

3) NAP pushed to early 2019. The government recently indicated that would publish the next National Automotive Policy (NAP) in the first quarter of 2019. This marks the third time it is delayed. The NAP will serve as a roadmap for the sector in the next four years. We understand it will continue to emphasize energy efficient vehicles, while focusing on four key areas: connected mobility, Industrial Revolution 4.0, new generation vehicles and artificial intelligence. The new NAP will also factor in the plan for the third national car, which has reportedly received over 20 proposals and will be led by the private sector. We understand that the NAP could also set a bigger stage for local suppliers to serve export markets as there are fewer barriers to entry for auto components compared to CBU cars.

• Growth in 2019 TIV will very much depend on the performance of volume-oriented players, namely Perodua, Honda, Toyota, Nissan and Mazda. Of these, we note that Mazda has had a stupendous year (as its monthly sales rebounded to an average of 1.3K units/month from only 811 in 2017), followed by Perodua (benefiting from the late entry of the Myvi in Dec 2017) while Honda, Toyota and Nissan are set to round up a decent year that largely leaned on the tax holiday.

• The sector still lags major organic catalysts although 2018 received a boon from the tax holiday in June-Aug, which accounted for 40% of 10MFY18 TIV. We believe the long-term catalysts for an upgrade on the sector are: (1) better consumer sentiment to drive demand; (2) for companies to be in a more solid financial position to catalyze demand with new models and better market visibility; (3) a better macroeconomic environment to ease the obtaining of auto financing. Note that more car loans were approved this year (the approval rate averaged 59% in 9M18 vs. 53% in 2017), but this was largely due to the last four months to Sept when the rate shot up to as high as 71%.

• Our BUYs are Bermaz Auto, Pecca Group, MBM Resources and Tan Chong Motor. Our BUY calls are on companies that we believe have a strong foundation to weather the sector’s tepidness and are addressing fundamental issues within their operations, if any were present. BAuto has a strong foundation in the domestic sales and exports of the CX-5 and the upcoming CX-8, Pecca is our key beneficiary of Perodua’s dominance here, MBM has seen results from the reform of its alloy wheel unit, while Tan Chong is led by stronger fundamentals and a more realistic strategy for Nissan.

• We have HOLDs on Sime Darby, UMW Holdings and DRB-Hicom, and an UNDERWEIGHT on APM Automotive. Of these, we are keeping a close eye on Sime Darby (for a more proactive stance on optimizing its bloated distribution business and divestment of non-core assets) and UMW (the group’s growth plans are comprehensive and inspire confidence, but valuations have been stretched). DRB benefits from the entry of the X70 but we caution that Proton continues to be opaque on the plans for the localization and export of the model.

Source: AmInvest Research - 12 Dec 2018