We are maintaining our Neutral rating on the automotive sector for 3Q12. Although there was a hiccup in the sector early this year, we believe that there will be a pent up demand in mid-2H12 where we expect sales to make a comeback after a prolonged drop last year. This view is further supported by our affordability study, which concludes that the average Malaysian household is still able to meet all its debt commitments and hence car affordability is still intact. In addition, we estimate that there will still be a long term CAGR growth in demand of 5.7% over the next 5 years from population growth and the replacement market. We are maintaining our total industry volume (TIV) sales forecast of 613,674 units (+2.3% growth) with a rebound seen likely in mid-2H of the year after the expected slowdown in the 1H, driven by pent-up demand and the industry's still positive long term dynamics as highlighted above. We are maintaining a Neutral view on the sector for 3Q12.      

As for stock picks, we prefer MBM Resources (OUTPERFORM; TP: RM3.91) given its current low valuation relative to its peers and potential catalysts from its upstream expansion. In line with our sector Neutral stance, we are maintaining our MARKET PERFORM calls on UMW (TP: RM7.98) and Tan Chong (TP: RM4.42). 

TIV May sales rebounded by 22.1% MoM. While there were some initial fears on the tighter lending guidelines by banks, May TIV sales have rebounded strongly with a rise of 22% and 27% on a MoM and YoY basis respectively. This appears to support our view that there will be a pent-up demand in 2H12 given the long term still strong demand dynamics of the sector. In other words, auto sales should rebound if it fell too long or too much at any single time (like the falls seen in last year and earlier this year). This is supported by our affordability study, which concludes that the average Malaysian household can still meet its current major debt commitments and purchase a car and a house within its means. 

Aggressive new launches. In addition, we believe that demand can theoretically still grow at a 5.7% CAGR over the next 5 years, based on its growth rate over the last 11 years from 2000-2011. We did a study on the population growth  and local market demand size and suggest that there is an adequate pool of buyers in the country to meet the long term growth of the industry above. Based on historical trends, car sales which had fallen in a particular year due to various reasons actually rebounded very strongly in subsequent years. This is due to pent-up demand driven by the industry's long term dynamics of continued affordability and rising pool of demand. Moreover,  we also saw more aggressive new car launches lately as the carmakers tried to make up for the lost sales last year. Some of the new models include Proton Preve, Nissan Almera, Honda City, Prius C, Prius facelift and others that should continue to lend support to the  demand growth. Our total industry volume (TIV) sales forecast of a rise of 2.3% remained unchanged for the whole year, with a rebound seen likely in the 2H after an expected slowdown in the 1H. 

Sector strategy.  The tactical strategy hence is to wait for the likely rebound in mid-2H of this year. We expect a pent-up demand and this should lead to a better YoY rebound for auto sales. Going forward, we are expecting the sector's average PER to be traded conservatively at around 10x-11x for FY12 based on  the targeted PERs of individual auto companies in our coverage. Against the overall sector's net earnings growth (47.9% for FY12 and 28.5% for FY13), the sector's targeted PER valuation of 10x-11x above is considered relatively undemanding.  

Source: Kenanga