We came away from the group’s 3Q14 results briefing with our CAUTIOUS view remain unchanged, with key takeaways of: (i) a more prudent inventory ordering in 2015 to avoid overstocking, (ii) limit CKD import order until the existing inventory is brought down to RM1.0bn-RM1.2bn from existing RM1.57bn, and (iii) higher localisation to mitigate the currency impact. While we lauded Tan Chong’s strategic positioning for the long haul and believe in management’s ability to steer the company well, we maintain our view for now as we believe any lights at the end of the tunnel could only be seen as early a 4Q2015. Post briefing, while we maintain our FY14E NP, we slashed our FY15E NP by 23% to account for: (i) lower vehicle sales assumption (lower by 7%) to reflect the prudent inventory ordering, and (ii) lower margins mainly for higher advertising and promotional expenses. With a lower earnings estimate, our TP is reduced to RM3.00 from RM3.61, based on a targeted PER multiple of 14x (being -0.5SD below its 3-year average forward PER). At the current price of RM3.98, the stock is trading at a rich valuation of 18x FY15 PER with no immediate re-rating catalyst in sight.  As such, we maintain our UNDERPERFORM rating.

Snapshots on 3Q14 results. On a YoY basis, while 3Q14 revenue only dropped by 10%, core PATAMI margin eroded by 4.9ppts to 1.2%, with sharp decline of 82% seen at core PATAMI of RM14.1m dragged down by: (i) the high discounts provided to push sales, and (ii) higher unfavourable forex on imported CKD. We were surprised to gather that Nissan Almera, being the lion share contributor (of 60%) to Tan Chong’s total passenger vehicles sales, were offered at cash rebate of as high as RM9,500 (vary by specs).

More prudent inventory ordering going forward. For the remaining of 2014, the group will limit its CKD import order until the existing inventory is brought down to RM1.0bn-RM1.2bn from existing RM1.57bn, a sign of sluggish sales. Meanwhile moving into 2015, instead of being aggressive for the sales target, the group plans to take a more defensive approach by being prudent in its inventory order in avoidance of overstocking, which could lead to rush of de-stocking eventually. We lauded the management strategy as this will minimise the trend of widening discount ranges as opposed of the current situation.

Currency trend is not in favour of the group. We gather that although the group does hedging for forex exposure to cushion against the adverse rates, the risks are not completely mitigated given the dynamic swing of volatility in USD vs. MYR (hovering between at RM3.15 to RM3.37 within 3 months period). Notably, the group’s current earnings profile is highly sensitive to the fluctuations of USD as 1/3 of the group’s costs consist of the forex components (dominated in USD and JPY with the ratio of 80:20). Management noted that a 10 sen change in USD vs MYR will fluctuate its PBT by c.RM60m. In view of the underlying undiversified risks, management has noted its plans to increase its average localisation rates of c.50% to as high as 60% in its popular models, coupled with the help of a higher localised supply chain in the medium-term, as ways to reduce exposure in forex.

Our take post briefing. While we lauded Tan Chong’s strategic positioning for the long haul and believe in management’s ability to steer the company well, we maintain our cautious view for now as we believe any lights at the end of the tunnel could only be seen as early as 4Q2015. At the current price of RM3.98, the stock is trading at a rich valuation of 18x FY15 PER with no immediate re-rating catalyst in sight. As such, we maintain our UNDERPERFORM rating.

Source: Kenanga