Investment Highlights

• We maintain our NEUTRAL stance on the auto sector. We strongly believe that Proton and Perodua will continue to underpin the auto sector in CY2020 as their products are more attractive in pricing and provide better value for money while we retain our bearish stance on foreign and premium car brands.

• We maintain our BUY recommendation on MBM Resources as the company has strong fundamentals and is sitting on a net cash of RM227.8mil. With that, we think that the group will be able to weather these difficult times, and deal with uncertainties better than its peers in our stock universe. Furthermore, stable dividends from the group should mitigate the downside risk to the share price. We also like Sime Darby as the group’s diversified distribution and services businesses across the Asia Pacific region in both the automotive and industrial sectors (i.e. BMW and Caterpillar) serve as a strong backbone to the group’s earnings. It can also act as a direct proxy to the improvement in the FBM KLCI should the selldown in the domestic equity market tapers off.

• Amidst the macro uncertainties and the Covid-19 pandemic, we strongly believe that consumer discretionary spending will be massively dampened. This will directly impact the purchases of big-ticket items such as cars.

• We would like to highlight a few salient points and our key views:

• To prevent the further spread of Covid-19, the Malaysian government has announced a nationwide movement control order (MCO) from 18 to 31 March 2020. Should new infections continue to increase, we do not discount the possibility of the MCO being extended beyond 31 March 2020. This will lead to vehicle production and deliveries to be temporarily halted and delayed across all brands. Channel checks have indicated that the imports of CBU vehicles will also be impacted as there will be no transportation to transfer those vehicles from the ports to showrooms/warehouses. In the wake of the MCO, we foresee consumers prioritizing spending. Consumers will put off purchasing bigticket items such as cars and instead will focus on utilizing discretionary spending to purchase the day-today essentials in the near to medium term; or at least until the Covid-19 pandemic tapers off.

• The slowdown in demand, production and delivery of vehicles will result in a prolonged inventory holding period. Companies will then need to utilize more borrowings/revolving credit to finance inventory costs, which will lead to higher interest payments. In respect to this, we are concerned about Tan Chong Motor’s outlook in the near to medium term as the group is known to have a persisting inventory problem, standing at more than RM1.5bil. We believe that this is due to the group’s inability to sell their vehicles due to uncompetitive pricing and unattractive product line-ups compared to its competitors.

• Taking the 1997–1998 Asian financial crisis as a comparison, TIV dropped from 404.8K to 163.9K units (-60% YoY) throughout the period. The domestic auto market suffered a loss of demand and confidence throughout the crisis resulting in devalued stock markets and other asset prices, and an elevated private debt. We think the quantum of the TIV decline will not be as bad as that of the Asian financial crisis. Nonetheless, we still expect a decline in consumer demand for cars and even more so for foreign and premium brands.

• The recent weakening of the ringgit is also a concern. The ringgit has weakened to a current level of RM4.40: US$1.00. Should the ringgit continue to weaken, it will ultimately be negative for the sector and automotive players in our coverage. Key companies that will suffer from a weaker ringgit will be Tan Chong, UMW Holdings and Pecca Group as a substantial amount of their COGS are denominated in USD at 60%, 40% and 40% respectively. Ceteris paribus, this will lead to heightened costs, consequently squeezing their net earnings.

• We believe that auto companies’ corporate earnings will be dragged down by the prolonged pandemic outbreak amidst weakened consumer confidence and decreased car sales. Despite potential further OPR cuts, we think that the minimal interest costs savings are unlikely to spur a sudden consumer interest and lift consumer confidence to purchase big-ticket items such as vehicles, or be a catalyst for growth for the auto sector. With that, we are cutting our earnings projection and valuations for all auto companies under our coverage as shown in Exhibit 2.

• We have compiled the trough forward P/E multiples during the 2008 global financial crisis (GFC) for comparison. Note that Bermaz Auto (BAuto) and Pecca Group were not listed at that time:

Source: AmInvest Research - 20 Mar 2020