-  We downgrade Tan Chong (TCM) to SELL (from HOLD) and cut our fair value to RM2.60/share from RM5.50/share previously, following the release of weak 2Q14 earnings.

-  TCM massively underperformed expectations in its 2Q14 result. The group reported core earnings of just RM12mil (excluding net tax write-back of RM41mil) for its 2Q14. This brought 1H14 core earnings to RM54mil, which accounted for 18% of our and 21% of consensus’ FY14F earnings.

-  We have cut our FY14/15/16F earnings by 52%/28%/22% to mainly reflect 11%-18% reduction in sales volume and increased price discounting over the forecast period. We now expect TCM to register a 52% fall in FY14F earnings while operating margins are expected at 4.6%-6.3% vs. an average of 7.7% for the past 4 years.

-  Core earnings fell 82% YoY and 70% QoQ on the back of a 5% YoY fall in revenue (-14% QoQ). Sales volume fell by 12% YoY (-15% QoQ). TCM has seen Nissan sales volume fall for six consecutive months since Feb 2014, notably, over the period leading to the launch of the new City in March 2014 (see chart 3). Nissan’s TIV started falling to below 4,000 units/month since Feb 2014 and this was sustained until July 2014.

-  Notably, the 2Q14 also reflected peak USD rates. The USD:MYR averaged at RM3.30 in 1Q14, which is reflected in the 2Q14 earnings as TCM stocks up 3-month forward inventories. While forex had eased, average YTD rate of RM3.24:USD is still below our FY14F assumption of RM3.20:USD. If forex stays at RM3.24:USD, there is another 12% cut to our FY14F.

-  This coupled with diseconomies of scale from volume deterioration and increased price discounting contributed to more than a halving in core operating margins to 4.6% in 2Q14.

-  Earnings momentum had sharply decelerated, driven by margin deterioration and volume pressure. TCM’s market positioning is now compromised. First, its key volume model faces stiff competition. TCM has yet to qualify its volume models for EEV incentives. This puts it at a disadvantage against EEV-qualified models, which benefit from incentive driven cost savings.

-  The delay in Nissan’s new A/B segment launch also hurts market expectations on TCM’s volume expansion. The group earlier targeted Nissan TIV hitting 100K by FY16F. TCM was expected to qualify its A/B segment model for EEV incentives, but this will be pushed out much later. Valuation is excessive at 24x FY14F earnings. Coupled with a steep turn in earnings revision cycle, we downgrade TCM to SELL.

Source: AmeSecurities