We maintain our NEUTRAL rating on the AUTOMOTIVE sector with an unchanged 2015 total industry volume (TIV) forecast of 667,000 units (flat growth assumption). According to the latest data from the Malaysian Automotive Association (MAA), May 2015 TIV rebounded 13% MoM which was reflective of the normalisation from low base. However, YoY growth still remained weak (-8%), sending YTD May’s 2015 TIV to 264,747 units (-4%) as opposed to our (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of +2% to 680,000 units). This suggests that consumer sentiment is still weak especially for big ticket item purchases. We believe auto sales will pick up in the 2H to make up for our flat TIV growth assumption, to be driven by aggressive A&P activities, festivities and stronger seasonal patterns. Recall that the 2H auto sales for the past three years accounted for 51-52% of the full year TIV numbers. On the flip side, we believe all these catalysts come at the expense of margins erosion. Another headwind, in our view, that will suppress margins is the old issue of unfavourable exchange rates, particularly auto players (in our portfolio universe: UMW and TCHONG) with high denominated USD costs due to the import of CBU vehicles, CKD packs and other components. Hence, we remain selective in our picks and prefer players that are less vulnerable to the weakening of MYR with its targeted customer base in the middle-income to high-income brackets that are less sensitive to the rising cost of living. Our Top Pick remains BJAUTO (OP, ex-TP: RM3.14) for investment merits backed by its: (i) superior growth prospect from low base on the back of strong pipeline of exciting models, (ii) margin's expansion on the back of favourable exchange rate (with huge exposure in Yen) as well as lower import duties, and (iii) potential dividend payout of 56%, which translate into c.5.2% dividend yield.

A disappointing 1QCY15 results. From the five stocks under our coverage, only DRBHCOM came in above our expectation whereas UMW and MBMR came in below expectations. Meanwhile, BJAUTO was in-line with higher-than-expected dividends payouts being the positive surprise (DPR at 56% vs. our conservative forecast of 40%). Zooming into the underperformers, the main culprits were mainly due to the subpar vehicle sales coupled with lower-than-expected margins from the vehicles and components price pressures and higher operating costs. Post-results, we have trimmed the earnings estimates of UMW, TCHONG and MBMR with its respective ratings remaining unchanged. While MBMR’s TP has been reduced accordingly, we marginally raised TPs for UMW and TCHONG as we rollover their valuation base year to FY16 as we expect to see better prospect ahead. For BJAUTO, we raised its TP to RM4.39 from RM4.29 as we have marginally tweaked its FY16E NP upward for house-keeping purposes.

Still a lacklustre May TIV. While May 2015 TIV rebounded 13% MoM which was a reflection of the normalisation from low base, the total sales came in weaker on a YoY basis (-8%). This suggests that consumer sentiment is still weak especially for the big ticket item purchases. By accounting for the recent May TIV of 51,254 units, YTD 5M15 TIV weakened further by 4%, as opposed to our (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of +2% to register 680,000 units). Looking at a more meaningful YoY comparison, among the national marques, sales of Perodua grew by 7% as opposed to Proton’s -18%, indicating that the new models of Perodua (facelifted-MyVi and Axia) are still gaining more traction than the latter’s models. On the other hand, within the major non-national passenger marques, Nissan was the only outperformer with better sales (+12% YoY) mainly helped by its facelifted Almera and new Nissan X-Trail. Meanwhile on YTD basis, sales growth of Proton and Toyota are still capped in the negative territory owing to the lack of attractive models launching.

A better 2H2015 ahead. We believe auto sales will pick up in the 2H underpinned by aggressive A&P activities, festivities and stronger seasonal patterns. Recall that the 2H auto sales for the past three years accounted for 51-52% to the full year TIV numbers. We believe auto companies will be more aggressive on A&P activities this year, to make up for the shortfall in 1H which was caused by weaker consumer sentiment on the back of GST implementation. Hence, we view that the stronger sales in the 2H are very likely to be at the expense of margins erosion. Another headwind in our view is the old issue of unfavourable exchange rates, particularly for the auto players (in our portfolio universe: UMW and TCHONG) with high denominated USD costs due to the import of CBU vehicles, CKD packs and other components. These have been evidenced in the subpar 1Q15 results of UMW and TCHONG where the higher CKD kits and CBU costs were the main culprit. Zooming further into these two stocks, while c.1/3 of both group’s costs are dominated in USD, the net fluctuation impact to UMW is relatively immaterial compared to TCHONG as the revenue of its listed subsidiary UMW Oil & Gas (90% derived from USD), acts as a natural hedge. Our sensitivity analysis suggests that for every 1% fluctuation in the USD from our base case, UMW’s bottomline could be affected by 3%. For TCHONG, its management noted that a 10 sen change in USD vs MYR fluctuate its PBT by as high as c.RM60m. We have imputed an average RM3.50/USD exchange rate for CY2015 for the abovementioned companies. On the other hand, BJAUTO is the apparent winner on the currency play as c.50% of its total costs is exposed to JPY, which is still weakening vs. MYR. With the on-going monetary stimulus programme implemented by Bank of Japan, we expect JPY to stay soft. We have imputed an average RM3.05/100JPY in the BJAUTO’s FY16E numbers. Based on our sensitivity analysis, every 1% decline in the JPY will have a positive impact to the group’s FY16E NPs by 5%.

BJAuto still on the go. We remain selective in our picks and prefer players that are less vulnerable to the weakening MYR with targeted customer base in the middle-income to high-income bracket that are less sensitive to the rising cost of living. In our coverage universe, BJAuto best fits in this category with investment merits backed by its: (i) superior growth prospect from low base on the back of strong pipeline of exciting models, (ii) margin's expansion on the back of favourable exchange rate (with huge exposure in Yen) as well as lower import duties, and (iii) potential dividend payout of 56%, which translate into c.5.2% dividend yield.

Source: Kenanga Research - 3 Jul 2015