We keep UMW as our top auto pick although its share price has surged 59% YTD, making it the top gainer on the FBM KLCI. The group's prospects promise to be exciting  as  it  emphasises  cost  cuts  while  pouring  in  more  capex  to  boost  the localization  rate  at  its  auto  unit.  The  turnaround  and  potential  listing  of  its  O&G business could perk up its valuation and pave the way for rerating at a higher PE multiple  of  14x,  just  like  the  heydays  in  FY06  when  this  division's  profits accounted for 20%-30% of UMW's total earnings. We maintain our BUY call, with an unchanged RM12.45 FV.

Aggressive  promotions  and  increasing  localization.  As  part  of  its  30th-anniversary celebrations,  UMW  has  been  aggressive  in  its  promotions  offering  downpayment rebates  of  RM3k  on  top  of  its  standard  sedan  offerings.  At  such  discounts,  the  price difference  between  its  best selling  model,  Vios,  and the cheaper  Nissan  Almera  would shrink from an average 8.5% to 4.5%. This will boost its attempt to maintain its lead in the B-segment line-up. With heavy discounts bolstering sales and the delivery of the all-new Hilux and the ToyotaFortuner (order taking commenced in mid-August), UMW's 4Q vehicle  sales  are  likely  to  improve  sequentially  and  buck  the  seasonally  weaker quarterly trend. The larger number of vehicles sold will  give rise to economies of scale, thus  boosting  profit  margins  and  offsetting  the  higher  spending  on  promotions.  UMW has  made  commitments  to  invest  up  to  RM1bn  from  2011  to  2013.  The  group  has incurred  an  estimated  RM700m  from  FY11-FY12,  leaving  RM300m  to  spend  in  2013. We think the money would be used for upcoming model launches, such as the all-new Vios and Altis (due 2H2013) as the current models are nearing their end-of-life cycles. In pouring  in  such  capex,  UMW  hopes  to  increase  its  localization  rate  '  now  averaging 40% - to 50% in the next few years.

Potential listing of O&G biz. The media has reported that UMW could potentially list its O&G division sometime next year to raise USD500m following several divestments of its non-core O&G stakes. We see this as a possibility sometime by 3Q or 4Q 2013 ' at the earliest ' given that the O&G businesses are still undergoing revamps. While details of the IPO are unclear, we estimate that UMW's O&G businesses, which are more heavily focused  on  upstream  drilling  activities,  could  potentially  fetch  a  PE  multiple  of  at  least 16x on FY13 earnings, representing  a steep discount to Sapura Kencana's 21x. UMW may see its O&G earnings surge to RM148m from RM70m in FY12, driven by the full-yearcontributions of the Naga 1 and Naga 4, as well as improved utilization of its pipe manufacturing plants and higher charter rates for its onshore rigs in the Middle East. At 16x PE multiple, the group's O&G businesses could potentially command a market cap of RM1.74bn. 

Rerating  catalyst.  The  potential  listing  of  its  O&G  business  could  perk up the group's valuations,  with  a potentially solid turnaround boosting a rerating to higher PE of 13x-15x from an average of 12x, just like the heydays in FY05-06 when this segment contributed 20%-30% of UMW's total earnings. We maintain our BUY call, with an unchanged FV of RM12.45. Our sum-of-parts calculation gives an implied valuation of 11.7x. 

 Source: OSK