Highlights/ Comments

• We attended a small group meeting with UMW Aerospace’s management yesterday to visit its new manufacturing facility for Rolls Royce fan case in Serendah.

• UMW has made its first step into high value manufacturing by entering into contract with Rolls Royce to manufacture fan case for Trent 1000 (Boeing 787) and Trent 7000 (Airbus A330) in Aug 2015 for a 25+5 years term.

• Under the contract, UMW Aerospace is able to pass-though the fluctuation of input costs (components and materials) and forex US$/RM exposure back to Rolls Royce (albeit lag of 6 mths period).

• The capex for the new manufacturing facility is RM750m, with 30% - 40% of the cost is for the equipment to manufacture the fan case. The land which currently UMW Aerospace occupies is rented from UMW Corporation.

• It has delivered its first fan case to Rolls Royce on 29 November 2017 and has completed 6 fan cases in 2017 and management expected to gradually ramp up production to 80 units in 2018, 160 units in 2019 and full capacity 250 units in 2020.

• The value and margins for the contract was not disclosed. However, management guided its earnings to only breakeven in 2019, indicating potential loss in 2018 (likely drag from high depreciation charges and interest expenses).

• Furthermore, management expects UMW M&E segment (including Aerospace) to contribute circa 10-15% of UMW Group revenue in 2022. Currently, the group revenue is within RM12-13bn per annum.

• We estimated the full ramp up revenue for the new facility to be circa RM1.0-1.2bn per annum based on full ramp up capacity, while the net margin to be circa 8-10%.

Risks

• Prolonged tightening of banks’ HP rules.

• Slowdown in the Malaysian economy affecting car sales.

• Global automotive supply chain disruption.

• Depreciation of RM.

• Drag from unlisted O&G and other segments.

Forecasts

• We have cut earnings for FY18-19 by 9% and 14.5% respectively after accounting lower than expected ramp up production for UMW Aerospace.

Rating

SELL ( ↔ )

• Despite benefiting from stronger RM (auto segment), we are concern on the rise of material costs (steel and aluminium) to the sector, as well as the continued drag from losses in unlisted O&G and other segments, while UMW Aerospace is not expected to contribute materially in FY18-19.

Valuation

• We have rolled forward our valuation into FY19-20 and increased our TP to RM5.20 (from RM4.63) based on SoP. However, we maintain SELL recommendation as we believe UMW’s share price has run ahead of its fundamental valuation, with unattractive dividend yield.

Source: Hong Leong Investment Bank Research - 10 Jan 2018