Tan Chong managed to record higher sales volume in FY18 following high demand during tax holiday period in Malaysia as well as higher demand for Nissan in Indochina. Management shared their interest to invest additional USD20m to expand Danang plant’s paint shop. The group’s inventory level increased in 4Q18 to cater for CNY sales and to supply for Indochina market. We raised our FY19 core net profit forecasts by 17.5% to account for higher sales volume and improved margin but cut FY20 by 2.9% following Vietnam JV termination effective Sep 2019. We maintain our HOLD rating with higher TP of RM1.77 (from RM1.57) based on 12x PE valuation into FY20f.

Results recap. Tan Chong reported 4Q18 net profit of RM117.5m bringing FY18 core PATAMI to MYR186.5m (vs. RM78.0m net loss in FY17) ahead our expectation as management attributed the turnaround to its Vietnam operations, favourable sales mix and improvement of RM against USD, which led to margin expansion.

Tax holiday period boosted higher sales. Total group sales volume in Malaysia improved to 30.3k units in FY18 (+5.9% YoY) due to surge in demand during tax holiday period and supported by new Serena Hybrid, which was introduced in May 2018. We expect Nissan sales to stay subdued in 2019 from the lack of new model launches and cautious automotive landscape. Tan Chong’s strategy to focus on high margin models has bear fruit as EBITDA margin expanded by 6.0ppts in FY18 from favourable sales mix.

Improvement of sales volume in Indochina. Total sales volume in the Indochina markets surged to 8.8k units (+27% YoY) in FY18, driven by higher Navara and Sunny sales volumes as well as introduction of new Terra, which boosted 4Q18 sales. Vietnam market managed to record higher YoY sales at 6.7k units (+22.0% YoY) despite implementation of Decree 116. We believe Vietnam will be able to sustain its growth supported by strong demand for Navara, Sunny and Terra as well cost optimization strategy in Danang plant.

Investment in Vietnam plant. Management foresees continued healthy growth trends in Indochina with Vietnam as the key market. The utilization rate of Danang plant in Vietnam currently stood at below 50%. Management is looking to allocate USD20m capex to expand Danang plant’s paint shop in order to cater for another model. Management has invested USD80m for the current Danang plant.

Higher inventory level in 4Q18. The group’s inventory level increased to RM1,239m in 4Q18 (ahead of their RM1.0bn target). The bulk of old inventory was from Malaysia side to cater for CNY sales and some purchases to supply to Vietnam and Myanmar market. We opine that inventory level will go down from 1Q19 following their strategy to minimize CKD kits purchases.

Forecast. We raised our FY19 core net profit forecasts by 17.5% to RM100.2m to account for higher sales volume and improved margin. However, we lowered FY20 core net profit by 2.9% to RM96.3m after taking into account the loss of CBU Nissan distribution from the group’s Vietnam JV termination.

Maintain HOLD, TP: RM1.77. We reiterate HOLD rating with higher TP of RM1.77 (from RM1.57), as we carry forward our 12x PE valuation into FY20f. Despite the strong earnings in FY18, we are cautious on the sustainability of the group’s earnings into FY19 given the expected RM depreciation against USD, cautious consumer sentiment and competitive automotive landscape. Moreover, Tan Chong will lose its distribution right for the highly profitable CBU models (Navara and Terra) in Vietnam by Sep 2019.

Source: Hong Leong Investment Bank Research - 27 Feb 2019