Investment Highlights

• 2Q19 results mostly in line with our expectations. Overall, the automotive and auto parts sector registered decent 2Q results, where 67% of core earnings of all companies under our coverage were in line while 33% were below our expectation. Negative surprises that resulted in a downward earnings revision were from Bermaz Auto (BAuto) and Pecca Group. BAuto’s core earnings came in below our estimates due to lower-than-expected vehicle car sales in both domestic and Philippine markets. Meanwhile, Pecca’s higher administrative expenses due to provisions for its employee performance programme dampened its earnings.

On the other hand, we raised MBM Resource’s (MBMR) valuations and earnings following an analyst briefing (FV: RM5.54) as we expect higher share of profit from its associate, Perodua ahead. Also, we have factored in higher estimates for sales volume which is expected to benefit from a refined delivery process and new Perodua launches.

• Two major downgrades. We recently downgraded Sime Darby (FV: RM2.64) and BAuto (FV: RM2.50). Sime Darby’s share price has risen 9% since our upgrade on 14 August 2019, and we believe that the stock is now fairly traded with limited upside.

We downgraded BAuto as we expect an earnings contraction for FY20 due to: i) heightened competition in the local market’s SUV segment; ii) a shift of consumer’s preferences towards cheaper and better value-for-money cars which has negatively impacted the premium segment vehicle car sales. Furthermore, we also expect BAuto’s Philippine operations to continue being sluggish in the foreseeable future due to the implementation of Tax Reform for Acceleration and Inclusion (TRAIN) law.

• 2Q2019 vs. 2Q2018. 2Q19 registered a total TIV sales of 153.3K units vs. 154.5K units in 2Q18, which is a marginal decline of 0.8% YoY. This was largely attributed to the tax holiday last year, which resulted in a positively skewed sales volume in June 2018. It is important to note that despite the absence of a major sales catalyst, Proton managed to outperform with a compelling sales volume of 25.2K units in 2Q19 compared with 14.3K units in 2Q18, translating into a whopping 77.0% growth in sales volume. This was backed by a slew of attractive and affordable new launches from the group’s volume-based models of Persona, Iriz and Saga.

Higher loan approval rate of 62.7% in 2Q19 vs. 54.0% in 2Q18. The average approval rate for loans in 2018 was 59.6%.

Cumulatively in 2Q19, core earnings of the automotive companies grew by 55% YoY to RM607.1mil. This was mainly attributed to two reasons: i) DRB-Hicom’s core earnings of RM45.6mil, which were supported by its improved automotive segment as it recorded operating profits compared with losses in 2Q18; and ii) Sime Darby’s significant 63% YoY earnings growth to RM315.0mil for the quarter, backed by the group’s stable deliveries of Caterpillar equipment. This was underpinned by growth in the mining industry in the Asia Pacific region with stronger demand for both mining equipment replacement cycles and expansions.

• Expecting an overall YoY contraction in sales volume for 3Q. Due to a high base from 2018’s tax holiday from June to August, we witnessed ramped-up numbers of sales volume from all major car marques in our radar. Without any major catalyst to boost automobile/auto parts sales this year, we anticipate a YoY contraction for the upcoming quarter (3Q19).

• New launches in 2H19:

• Perodua: All-new Axia crossover (September) and facelift Bezza (tentatively December);

• Honda: Facelift Civic 2019 (currently open for booking nationwide); tentative launch in 4Q19;

• Toyota: All-new Toyota Corolla 2019 (currently open for booking); tentative launch in 4Q19;

• Mazda: CX-3 (December), CX-5 CKD (September), CX-8 CKD (October), CX-30 (December).

• Given the recent major downgrades in Sime Darby and BAuto, we are downgrading the sector to NEUTRAL from OVERWEIGHT as Sime Darby makes up 49% of our coverage’s weightage with a market capitalization of approximately RM15.9bil. Nevertheless, we continue to be optimistic on the national car marques Proton and Perodua while staying cautious on the foreign and premium car brands as consumers change their preferences towards cheaper and better value-for-money vehicles.

• Our top picks for the auto sector are DRB-Hicom (FV: RM3.18) and MBM Resources (FV: RM5.54) riding on the strong sales of Proton and Perodua vehicles which command the bulk of the market share in terms of TIV sales.

Source: AmInvest Research - 20 Sept 2019