-  We maintain our HOLD call on UMW but lower our (FY14F-based) SOP-derived fair value to RM12.00/share (from RM12.20/share) after the release of its 2Q14 results.

-  UMW’s 2Q14 came in short of our estimates but within consensus. The group reported core net profit of RM235mil for 2Q14 (ex-RM93mil provision for disposal of investment in Indian auto component business), which brought 1H14 core earnings to RM471mil. Group core earnings were flat sequentially and dropped 6% YoY. Operating margins fell to 9.7% in 2Q14 from 12.1% in 1Q14.

-  The 2Q14 clearly reflects the tough operating environment for the auto sector. The auto division’s pretax earnings were flat despite a reported 9% QoQ revenue growth (11% QoQ rise in Toyota TIV), reflecting stiff competition and price discounting in the market. Pretax margins contracted 1.2pp QoQ to 14.1%.

-  The strong rise in auto division earnings on a YoY basis has to be taken into context with the diseconomies of scale, lack of new model launches and pre-election holdback in purchases in 1H13. The structural deterioration in sector margins (as seen from Tan Chong and UMW Toyota’s latest results) from 2Q14 is a developing risk to earnings trajectory.

-  Furthermore, UMW Toyota has so far benefitted from a volume recovery driven by the new Vios and Altis in late 4Q13 and 1Q14 respectively. However, there are no more major new launches for the rest of the year. Entry of several competing B-segment models further increases margin risk heading into the 2H.

-  The O&G division saw good growth, but earnings disappointed our forecast given lower-than-expected utilisation of Naga 3 as the rig had to undergo 23 days of repair for its damaged ballast tanks in May 2014.

-  We trim FY14F/15F/16F earnings by 7%/4%/5% to factor in:- (1) increased discounting and A&P cost for the auto division; and (2) lower utilisation for Naga 3. The bulk of FY15F growth (+9.5% YoY) is now expected to come from the oil & gas division – 3 new jack-up rigs will come on-stream in Sep 2014, Dec 2014 and Sep 2015. We are 2%/4% below consensus over the FY14F/15F forecast period.

-  At 16x FY14F earnings, UMW is the most expensive stock in the sector (and trades above historical average PE of 15x), amid increasingly muted earnings visibility. While UMW provides cheaper entry into UMW Oil & Gas, growth impact is significantly diluted as it accounts for just 16% of group earnings.

Source: AmeSecurities