We initiate coverage of MBM Resources (MBM) with a BUY call anda fair value of RM5.80/share. Our sum-of-parts derived valuation implies 9xFY12F earnings, a conservative 10% discount to sector PE of 10x. Our highconviction BUY on MBM is premised on several factors: (1) A strategic businessmodel re-engineering; (2) A close to quadrupling of core earnings base by FY13F;(3) A deeply undervalued stake in Perodua.

A structural valuation re-rating is imminent from thecurrent low base PE of 7x (sector average: 10x) as MBM breaks out of the investmentco stigma tagged to it (given that 70% of earnings is currently derived viaassociates). MBM is on the verge of a major business model transformation, froma mere investment company into one with a complete vehicle assembly, distributionand parts making capacity, akin to that of DRBHicom, UMW and Tan Chong. Theseauto manufacturing incumbents are currently trading at 40%-90% premium to MBM'sdepressed valuation (See Table 4).

The building blocks of such an infrastructure are in place:(1) Comprehensive vehicle manufacturing license via the acquisition of KMASBand LMSB in 2010; (2) A ready distribution network via 40 strong outletsnationwide, which are easily expandable; (3) Part making capacity in SRSproducts and wheels which can attract 2%-3% localization rate, on top of 10%-15%localisation derived from local assembly. 

Post recapitalization, MBM will be on a stronger footing togear up for massive expansion. An estimated RM105mil proceeds from the rightsissue will lower MBM's net gearing to 12% (from 20% FY12F) and expand equity by8%. We estimate MBM has the capacity to raise RM1.1bil to finance construction/acquisitionof assembly plants and expand distribution capacity. Potential assemblycapacity of 60K-70K/annum (our estimates) can position MBM at par to DRBHicomand Naza (See Table 5). We believe MBM is next to be thrusted into thelocal-foreign partnership spotlight after NazaPeugeot and DRB-VW.

In the near-to-mid term, a close to quadrupling of coreoperating profits - from RM42mil in FY11 to RM155mil in FY13F should catalyzestrong re-rating of the stock. The 23% FY11-13F core earnings CAGR will bedriven by the (1) Expansion of auto parts manufacturing division; (2) Expansionof VW dealership network to ride on the principal's massive expansion withinthe next 3 years; (3) MBM's maiden expansion into alloy wheel manufacturing. 

Finally, we think MBM's effective 23.5% stake in Perodua is deeplyundervalued. At current market cap, MBM's stake in Perodua is valued at just 6xFY12F earnings (net of MBM's direct 20% stake), half of UMW's (the other localshareholder of Perodua with a 38% stake) valuation of 12x. Notably, Proton is beingprivatised by DRB at 28x forward earnings.

Source: AmeSecurities