The 1Q earnings of the automotive companies we cover were broadly in line with our estimates, with MBM outperforming and Tan Chong disappointing. Earnings were driven by vehicle sales but there were no major surprises on the cost side, which leads us to conclude that y-o-y margins were generally intact. The outlook is expected to improve as demand tends to pick up in 2Q, as well as due to the exceptionally low base in 1Q. We maintain our NEUTRAL rating on autos as most of the stocks are already trading at their historical average forward PERs. We advise investors to buy companies with strong earnings growth in the immediate term, such as UMW (BUY, FV: RM9.55) and MBM (BUY, FV: RM4.58).

Generally within. The 1Q earnings for the automotive stocks under our coverage were broadly in line with our expectations. MBM, the sector's outperformer, posting earnings there were largely in line with our estimates but overtook those of consensus. Hirotako's high-margin air bag business boosted MBM's overall EBITDA margin (+1.4ppts to 5.9%) while there were encouraging earnings (+4.8% y-o-y) from Perodua as the localization rate for its new Myvi increased. UMW's earnings were within our estimates, propelled by robust sales of several new models, as well as the turnaround of its oil and gas division and better heavy equipment orders. On the other hand, Tan Chong's 1Q earnings were disappointingly below our and consensus forecasts as weak vehicle sales led to a 13.2% drop in revenue. Operating inefficiencies due to supply chain disruptions, disappointing sales at its Vietnam venture and continued start-up losses added to the group's woes. This prompted us to slash Tan Chong's earnings and fair value. On the autoparts side, EPMB and Delloyd Ventures' earnings were largely within forecasts, as volume was seasonally higher q-o-q and y-o-y as new orders ahead of the Proton Preve launch flowed in. Unfortunately, despite the higher autoparts volume procured, actual vehicle sales were sluggish as a result of the tighter lending guidelines imposed by Bank Negara.

Margins generally positive. Save for Tan Chong's disappointing numbers, the earnings performance of most of the auto stocks was generally in line with their respective vehicle sales. There being no major surprises on the cost side, we conclude that y-o-y margins were generally intact.

The 2Q outlook. 2Q is generally a seasonally stronger quarter for TIV. This time around, 1Q TIV (total industry volume) was exceptionally weaker, squeezed by the tightening lending rules. This dented sales of entry-level vehicles as the loan approval rate declined. We anticipate the numbers to be relatively stronger on a sequential basis as the banks adapt to the new loan processing procedures, whereby the number of days taken to process a loan has been lengthened from 3 days to more than a week. This was still an improvement over the duration taken during the first month the new rules took effect. There is no significant model launch in 2Q that may make a significant impact on overall TIV other than the widely anticipated new Toyota Camry. We suspect that vehicle numbers in 2Q would largely be driven by Perodua and Proton.

The upcoming NAP. While there have been hints that the revised NAP may be unveiled soon, our industry sources think that it will likely be announced sometime in 3Q. As we stated earlier, the emphasis of the upcoming NAP will be on boosting investments. The media has reported that the Government is considering reopening the 1.8-liter vehicle segment to foreigners. While the restriction on 100% foreign ownership in manufacturing plants was lifted in the last NAP in 2009, this was confined to the production of vehicles priced above RM150,000 each. We do not rule out the possibility of the Government further relaxing the price criteria, which may pave the way for the entry of other automakers. We also understand that the Government, together with consultants and industry players, is currently reviewing key aspects pertaining to the sector in its efforts to boost investment in manufacturing hybrids and electric vehicles and gradually phase out Approved Permits (AP). 

Downside risk to OSK's TIV forecasts. TIV for Apr '12 continued to decline, falling by 6.3% y-o-y and 10.9% m-o-m (YTD: -11%) as sales hit the brakes as the stricter lending guidelines took effect, despite the encouraging bookings. We maintain our 2012 TIV growth forecast of 1.1% for now, although we caution that there is a downside risk to our numbers should a significant rebound fail to materialize in the coming months. That said, the national automakers would be the worst hit, with the entry-level cars bearing the biggest blow. This would in turn adversely affect MBM Resources and UMW's profits.

Maintain NEUTRAL.  Overall, we are still cautious on the macro picture for autos as we think the demand upside would be marginal since: (i) the replacement cycle for new vehicles, which may boost sales, has peaked, (ii) the upcoming models may lack the excitement to sufficiently spur TIV growth, (iii) bankers are tightening on lending and becoming more stringent in approving loans, and (iv) consumer sentiment is deteriorating and buyers have become more cautious. We maintain our NEUTRAL call on the Automotive sector. UMW and MBM are still our top sector Buys, at FVs of RM9.55 and RM4.58 respectively. From a valuation standpoint, the auto stocks in our coverage are mostly trading at their historical forward PE average of 10x (for automakers and assemblers). As such, we advocate that investors buy into companies with strong earnings growth over the immediate term such as UMW and MBM. We also have a TRADING BUY call on EPMB (FV, RM0.94) as the share price has been severely bashed down. We are Neutral on Delloyd Ventures (FV: RM3.88) while Tan Chong is a SELL (FV: RM3.60).

Source: OSK