TIV plunged in Jan 2012 on slower business activities in amonth shortened by fewer working days due to the Lunar New Year holidays. Whilethe tighter lending rules have dampened vehicle sales, its impact should bemanageable as banks and dealers adapt to the situation.  Given that we haveno SELLs in our auto coverage, we upgrade our sector call from UNDERWEIGHT toNEUTRAL, with UMW as our top pick. We are  still cautious on the macropicture  though, as the demand upsidewould be marginal since the replacement cycle for new vehicles -a  potential sales driver  - has peaked and  upcoming models may  lack the excitement to spur TIV amiddeteriorating consumer sentiment.

Tighter lending.  TIV for the month of January dropped by asharp 25% y-o-y. The Proton Dealers Association claimed that loan approvalrates have fallen to 30% against the usual 45%'50% owing to Bank Negara's newlending guidelines. Under the new guidelines, credit approval will now bedetermined by calculating the 'debt service ratio' based on a purchaser's netincome (which is a smaller denominator) instead of gross income previously.Proper documentation is also needed and any additional income must be backed bysupporting documents, while lending to civil servants will be capped at a debtservice ratio of 60% versus 70%-75% previously.

TIV drop due to fewerworking days. Business activities tend to be slower at the start of the newyear and the fact that the Chinese New Year fell in January aggravated this slowdown.Furthermore, bonuses are usually not paid so early in the year, and such incomecan sway consumers when it comes to the timing in purchasing big ticket items. Wesee the drop in TIV as being weighed down more by the shorter work month in combinationwith the autoparts shortage sparked off by the Thai floods, rather than due toa higher rejection rate for car loans per se. To point out, loans applied inthe banking system for the purpose of purchasing passenger vehicles in Januaryhas also dropped by 15% y-o-y to RM6.16bn, while loans approved were down by15% y-o-y, which has resulted to a drop of 25% y-o-y in vehicle sales for themonth. Furthermore, the ratio of loans approved to loans applied for hasremained at 49.7%, just 2.58ppt higher m-o-m but 1.77ppts lower y-o-y.Excluding the distortion relating o the Chinese New Year, a more appropriatemeasure would be to compare sales in Jan 2012 against that in Feb 2011, duringwhich  vehicle sales were higher by 1.4%while loans applied for and approved were higher by 17% and 14% respectively(see Figure 1 below).  The higher growthin loans was, however, overstated given that numbers achieved in February last yearwas due to the lower base arising from to the fewer working days.

Banks get cautioustoo. In complying with the  newguidelines, banks  have  become stricter on documentation and more stringent in initial screening, whichhas certainly has put a dent on vehicle sales. On the other hand, this may getmore manageable as banks and car dealers adapt to and familiarize themselves withthe new submission procedure, which has led to the overall loan applicationperiod stretching to a week versus the usual 1-2 days. We understand that  the applicants  most hit by the  new guidelines  are civil servants, who are unable to producesupporting documents on their side income. The more stringent lending rulesmay, however, be a boost for  financingcompanies owned by auto players such as Toyota Capital (owned by UMW, financingboth Perodua and Toyota marques) and TC Capital Resources (owned by Tan Chong,financing Nissan marques), both of which are not under the direct purview ofBank Negara. Our latest checks reveal that financing companies backed byautomotive groups were not affected by declining approval rates other than theslowdown in sales due to the shorter working month. However, the smallerbalance sheet of these financing companies relative to the banks limits theirability to provide financing for car purchases.

What we expect forFebruary 2012 TIV. We expect TIV to pick by 20-25% y-o-y and m-o-m inFebruary as business activities normalize, although YTD TIV will continue tosee single digit negative growth, taking into consideration the possibilitythat loan applications may temporarily hit a snag due to the more stringent andlonger loan approval process.

Buyers may deferpurchases pending new model launches. We also reckon Proton sales may slowdown as buyers defer their purchasing decision in anticipation of the newPersona replacement being launched at end-March. We tested the car last weekand the general feedback among the fund managers and analysts from the trialdrives has been largely positive. We see this purchase delay  similarlyaffecting  the D and E segments, as wellprior to the launch of the new localized Camry, which will likely be cheaperthan the CBU model by as much as 15%.

Consumers getcautious. Consumer sentiment remains cautious overall in light of the weakunemployment outlook amid uncertainty in the overall economy; but we think TIVcould still grow marginally by 1.1% as new model launches could continue tospur interest. In addition, the replacement cycle for new vehicles that can usuallybe counted on to boost sales, has peaked. We expect next year's  TIV to inch up by a mild 1.1%, based on aforecast 2012 GDP growth of 5.2%.

What the NAP can  offer. The media reported that theGovernment is considering reopening the 1.8-liter vehicle segment toforeigners. The restriction on foreigners with 100% ownership in manufacturingplants was lifted in the last NAP in 2009, but this was confined to theproduction of vehicles priced above RM150,000. We do not rule out thepossibility of the Government further relaxing the price criteria, which may pave the way for the entry ofother automakers. We  also  understand that currently the Government,together with consultants and industry players, is reviewing key aspectspertaining to the sector in its efforts to drive investment in manufacturinghybrids and electric vehicles and gradually phase out Approved Permits(AP).  The revised NAP is due to beannounced in the next two months.

The Outlook for companies under our coverage is detailed inthe following pages.

- UMW (BUY, FV:RM7.88). UMW is now our auto sector's top pick, on account of theturnaround of its oil and gas segment on securing  more  oil and gas jobs  and a foreseeable  better year for its equipmentand manufacturing division. While the auto segment may see modest revenuegrowth, we think its margins  may improvetremendously  this year driven by  a higher localization rate (for the upcoming Camry), as well as a  stronger ringgit. As for Perodua, we  see volume growth fuelled by resilient demand, and expect the company to grow earnings by double digits for the third consecutiveyear at 14% in 2012.  This  automaker also offers an attractivepotential  net  dividend yield of 4.4%. We have a FV ofRM7.88 based on SOP (as below), with a BUY call on UMW.

- Tan Chong (NEUTRAL,FV: RM4.00). With the recently launched all-new Nissan Vanette and the upcomingB segment CKD sedan (a new segment where Nissan will be competing head-on with Toyota'sVios) slated for launch in September and a number of CBU models in thepipeline, we see a better 2HFY12. Furthermore, its Danang plant should beoperational as early as March this year, with a monthly production target of1,200 units, of which some would be exported to China. Nonetheless, the 1Houtlook should remain challenging as demand for its best selling Grand Livina continuesto be lackluster in view of the intensifying competition in the MPV segment.Given the higher revenue driven by a 18% growth in vehicle volume for FY12(Malaysia and Vietnam combined), we see Tan Chong's earnings growing by 18.4%y-o-y.  We have a  FV of RM4.00 premised at 10x FY12 PE.Maintain NEUTRAL.

- MBM (BUY, FV:RM5.34). While the recent rights issue raises concerns on a dilution in itsearnings base, we think this will be compensated by the earnings accretionpotential from Hirotako and the interest cost savings it will achieve uponraising the desired optimized capital. The company's longer term prospectsremain  reassuring, with the upcomingalloy wheel plant to generate further revenue and the possibility of MBM crossselling airbags to Indonesia. MBM is morphing into an established integratedplayer with exposure across broad segments and across various supply chains inthe automotive sector.  We have a FV ofRM5.34 based on SOP (see table 6 overleaf).

- Proton (NEUTRAL,FV: RM5.50).  We have yet to turnoptimistic on  Proton's  outlook in the immediate term despite DRB'simpending  takeover  as  many  issues remain unresolved  in turning aroundthe national automaker and ensuring that it generates decent profits. However,we do agree that DRB's entry as a strategic partner and the possibility ofVolkswagen localizing production would be positive for Proton. Our reservationrests on how fast DRB can cut costs through its vendor rationalization. Wethink such a process will not materialize immediately as one will have toaddress the issue of supply chain continuity and renewing its product design.Our FV at RM5.50 is based on DRB's offer price.

- Delloyd Ventures(NEUTRAL, FV: RM3.88) and EPMB (BUY, FV: RM1.38). We expect autoparts makersto post better earnings this year on improved volume  as assemblers localize more of their productionin Malaysia,  thus  allowing them to reach bigger  economies of scale. There may be potentialsizeable contracts from Volkswagen, which we see setting up an ASEAN productionbase in Malaysia  while  Daihatsu Motor Corp's aggressive expansioninto  Indonesia may potentially see Malaysianautomakers  become its  parts sourcing partners. Our valuation onDelloyd and EPMB is based on 7x and 5x FY12 EPS respectively.

Upgrade sector toNEUTRAL. As we have no SELLs among our auto coverage currently, we upgradeour sector call from UNDERWEIGHT to NEUTRAL, with UMW as our top pick. Overall,we are still cautious on the macro picture for autos as we think the demandupside would be marginal since: (i) the replacement cycle for new vehicles,which may  boost  sales, has peaked, (ii) upcoming models maynot create enough excitement to sufficiently spur TIV growth, (iii) bankers aretightening lending and becoming more stringent in approving loans, and (iv)consumer sentiment is deteriorating and buyers have become more cautious.

Source: OSK188