-  We maintain our SELL call on Tan Chong (TCM) after its post-results briefing yesterday. Our fair value is raised to RM3.50/share (from RM2.60/share previously) as we roll-over our valuation to FY15F, but the outlook painted by management is worse than expected.

-  We trim our FY14F/15F/16F earnings by a further 37%/26%/29% to factor in:- (1) higher import cost given stronger USD assumption for FY14F; and (2) 1%/8%/12% lower volumes in FY14F/15F/16F. Our revised FY15F forecast already factors in weaker USD (at RM3.20) vs. FY14F (RM3.25), while volumes are assumed to recover by 14%. Still, we are 28%-52% below consensus over FY14F- 16F.

-  Management expects the tough environment to persist through 2H14, till end-FY15F, in a pessimistic scenario. Key factors cited were:- (1) excessive stock in the channel is driving heavy price discounting; (2) tighter financing affects 2nd hand values, translating into higher requirement for overtrades or discounts for new cars by buyers – this forces TCM to give away margins; (3) inventories locked in at expensive forex; and (3) tough competition from new B-segment launches, especially the City and Jazz. FY14 will see >60 new model launches.

-  A TCM-specific issue was widening losses at NVL given there were almost no sales in 2Q14 and it was simply running down existing inventories in 1Q14. NVL registered LBT of RM8mil in 1H14 while its manufacturing plant registered an LBT of RM17mil. NVL should see some recovery in 2H14, but the plant is still well below breakeven – normal prod rate: 200-300/mth vs. ~420/mth breakeven volume.

-  Contract assembly for Subaru XV saw volume reduction given slower end sales for the model, which is also affected by the abovementioned factors. Though total volume assembled is secured by contracts, contribution will vary from month-to-month.

-  Being a low margin-high volume segment, the B-segment requires huge capacity and working capital requirement. TCM is a relatively small player stuck with high fixed investments and hence is less nimble in a downcycle. The B-segment is the worst hit in this case. Earlier planned launch of A/B segment models are pushed out to FY17F.

-  Management is exploring balance sheet management to optimise resources and free up cash, but this could take up to 12-24 months. TCM is also reducing FY14-15F capex by 47% and held back CKD orders over Apr-June 14, but re-ordered since Aug 14.

-  At 18x FY15F earnings, TCM trades well above the historical average of 12x. Given stretched valuations, muted earnings visibility and increasingly steep downward revision cycle, a further de-rating looks imminent.

Source: AmeSecurities