Investment Highlights

• We had a meeting with Hap Seng Consolidated last week to discuss on the outlook for Mercedes-Benz from its position as a leading dealer of cars in the luxury segment.

• The group is the second-largest dealer for Mercedes-Benz Malaysia (MBM) after Cycle & Carriage Bintang and it last accounted for 36% of the TIV of Mercedes-Benz locally. Some quick facts on Hap Seng and MBM: 1) Hap Seng's automotive segment contributes 21% of group's revenue and 3% of its operating profit, owing to the thin margin which is typical for car dealers. Key segments contributing to the group's bottomline are property investment & development, plantation and building materials. 2) MBM saw sales growing 2.3% last year to 12K units with volume still anchored to its GLC, E-Class and C-Class. For comparison, BMW’s sales went up 18% YoY to 10.6K units. MBM launched 17 new cars last year (the same number as 2016), with updates varying from minor changes to exterior modification and to the introduction of brand new versions. The group will have 7 dealerships in the Klang Valley by year-end (with the addition of Puchong South) while in East Malaysia, it has 3.

• Key points from the meeting: 1) Creativity and caution are the dealer's main tools. MBM, as the principal, makes decisions on the key points of a sales strategy: new models, new dealership locations, and the packaging of a car (its price and the after-sales support a customer is entitled to). The key moves for Hap Seng are targeted advertising (roadshows that link the prospective customer directly to its own dealerships as opposed to the brand-focused advertising done by MBM) and doling out of discounts (which it has a limited bandwidth given the thin margin for a dealer). 2) The brand's longevity depends on attracting new types of customers. It has made a big effort to court young buyers by launching compact cars that come at lower price points (the A-Class sedan is available from ~RM210K), financing options that aim to lighten the monthly repayment (agility financing and lease2go) and training its salespeople to accommodate a more diverse range of buyers. 3) The used car market could one day offer better returns but it is trickier to navigate. Hap Seng guided that auto sales in mature markets is leaning towards used cars as the returns for dealers from new cars shrink. It entered the used car market three years ago and is working to make this a more lucrative operation. The two steps it is taking are to set a more visible stage for used cars (which will have their own centre in Hap Seng's Kinrara dealership, from its current base the second floor of its Balakong outlet) and recruit the right staff (which it says are scarce; the ideal salesperson must be able to work with the relative uncertainty of the used car market where prices are more dynamic). 4) Expansion is for the long haul. MBM has identified locations for new dealerships in the coming years. These may not be prime locations for Mercedes-Benz sales today, but demographic factors point towards a rise in the average household income. Hap Seng's most recent outlets were set up in Bukit Tinggi (Klang) and Iskandar (Johor), and the cost for a new one could reach RM70mil.

• We came away from the meeting with the group COO/head of automotive with a better sense of the challenges and opportunities it faced as a dealer. We understand that concerns for car prices and affordability persist even for customers within the premium or luxury segment, and carmakers on this end are finding ways to hold up sales in this environment. Most of them saw lacklustre growth (11MFY17 Audi: -26% YoY, Lexus: -28% YoY), while BMW and Volvo proved to be exceptions.

• Given the less-than-rosy outlook, we lower our TIV projection for 2018 to 2-3% (from 5% before). We believe that massmarket brands such as Honda, Toyota and Perodua will plot a clearer rebound from the massive plunge seen in 2016.We maintain NEUTRAL on the automobile sector with BUYs on Bermaz Auto and Pecca Group; and HOLDs on DRB-Hicom, UMW Holdings, Tan Chong Motor Holdings, MBM Resources, Sime Darby and a SELL on APM Automotive.

Source: AmInvest Research - 23 Jan 2018