Highlights/ Comments

• UMW has entered into agreement with Rolls Royce (RR) to assemble and supply fan cases for RR’s “Trent 1000” aero engines for Boeing 787 Dreamliner. The agreement will commence on 12th August 2015 and expire on 31st December 2040, with an option to extend for up to five years. The agreement forms part of RR’s program for production facilities closer to demand growth region.

• Both parties will also collaborate in areas of strategic interest in seeking relevant and strategic partnerships towards establishing a supply chain foot print in the region.

• UMW will build a new production facility for the venture with an estimated investment of RM830m. The facility is targeted to commence production by 4Q17. However, management has not yet finalized details for the production agreement and facility yet.

• The fan cases will be delivered to RR’s facility in Singapore which is currently producing “Trent 900”, “Trent 1000” and “Trent XWB”. The facility is still undergoing ramping up process, which will eventually achieve the designed maximum capacity of 250 units p.a. by 2016.

• Judging from the performance of CRTM (subsidiary of DRB) and Sam Engineering, PBT margin for comparables ranges from 7.5-10%. We expect the agreement includes cost past - through elements (standard practice in the industry).

• We are overall positive on UMW’s strategic move into MRO segment (high - value manufacturing venture) in tandem with RR’s supply chain strategy in South East Asia.

Risks

• Prolonged tightening of banks’ HP rules.
• Slowdown in the Malaysian economy affecting car sales.
• Global automotive supply chain disruption.
• Appreciation of US$.
• Plunge in crude oil price and slowdown in O&G exploration.

Forecasts

• Unchanged. The venture is only expected to start contribution by end 2017.

Rating

SELL

Positives

• 1) Control largest market share of Malaysia TIV with leading brand - Toyota, Lexus and Perodua; and 2) Expanding reach of Manufacturing & Engineering division into huge markets like China and India.

Negatives

• 1) Slump in crude oil prices affecting demand and charter rates for jack-up rigs; 2) Tightening of bank’s lending rules; and 3) Intense competition from rival automotive marques.

Valuation

• Maintained SELL on UMW with unchanged Target Price of RM9.44 based on SOP. However, we acknowledge risk of further earnings downgrades given the expected disappointment in UMWOG and weakening prospect of Toyota from MYR depreciation, weak consumer sentiment and competitive market.

Source: Hong Leong Investment Bank Research - 13 Aug 2015