We maintain our NEUTRAL rating on the Automotive sector. According to the latest data from the Malaysian Automotive Association (MAA), July’s total industry volume (TIV) extended its gains sequentially at 58,646 units (+2%) driven by aggressive sales campaign amidst the Hari Raya festive season. However, YoY sales were still soft (-3%), capping YTD7M15 TIV in the negative territory (-3%) as opposed to our forecast (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of +0.5% to register 670,000 units). We believe auto sales will pick up in the 2H to catch up to our TIV growth albeit flat assumption, underpinned by aggressive A&P activities (at the expense of margins), festivities and stronger seasonal patterns. On the upcoming auto companies’ 2QCY15 results that will be released next week (namely UMW, TCHONG and DRBHCOM), we see potential earnings risks owing to weaker sales (sluggish TIV in April and May) and margins erosions (arising from the heavy discounts and unfavourable currency fluctuation). On stock selection, as the trend of weak MYR vs USD still persists amid the cloudy local economy outlook, we prefer to stick with auto players that : (i) are less vulnerable to the unfavourable currency translation, and (ii) have targeted customer base in the middleincome to high-income bracket which are less sensitive to the rising cost of living. Our Top Pick remains with BJAUTO (OP, TP: RM3.14) with investment merits backed by its: (i) superior growth prospect from low base on the back of strong pipeline of exciting models, (ii) margin 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 could translate into attractive 7.3% dividend yield. Following its recent share price weakness, the stock is currently trading at an undemanding 7.7x forward PER, which is at 23% discount to its industry forward average PER of 10.0x.

MoM improvement insufficient to lift the sluggish YTD TIV. While July 2015 TIV extended its gains (+2% MoM at 58,646 units) after the strong sequential improvement seen in June; driven by aggressive sales campaigns during the Hari Raya festive season, YoY total sales still lacklustre at -3%. As a result, YTD7M15 TIV is still capped in the negative territory of -3% as opposed to our (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of +2% to register 670,000 units). For July, most of the major passenger marques recorded better TIV sales sequentially, with exceptions in Toyota and Honda (-20% and -3% respectively). While we view the softness in Honda's sales (-2%) as a normalization from the high base effect, the pallid Toyota sales was due to the lack of attractive models launching. Looking at a more meaningful YoY comparison, Honda and Nissan sales continued to outperform which we believe were helped by its respective new models (Honda: HRV; Nissan: facelifted Almera and new Nissan X-Trail). Meanwhile on YTD basis, sales of Proton and Toyota still lagged against industry growth.

Better 2H15 TIV to make up for the shortfall in 1H. We believe auto sales will continue its momentum sequentially underpinned by aggressive A&P activities, festivities and stronger seasonal patterns, even after three consecutive months of improvement. Recall that the 2H auto sales for the past three years accounted for 51-52% to the full year TIV numbers. Meanwhile, to make up for the lagging sales caused by weaker consumer sentiment in 1H, we believe auto companies will be more aggressive on A&P activities for the remaining months of 2015. Thus, we view that stronger sales in the 2H could very likely to be at the expense of margins.

Weak MYR continues to suppress the auto players’ margins, particularly to those (in our portfolio universe: UMW and TCHONG) with high denominated USD costs due to the import of CBU vehicles, CKD packs and other components. This is evident from the subpar 1Q15 results of UMW and TCHONG where the higher CKD kits and CBU costs were the main culprits. On the upcoming auto companies’ 2QCY15 results that will be released next week (namely UMW, TCHONG and DRBHCOM), we see potential earnings risks owing to weaker sales and margins erosions (arising from the heavy discounts and unfavourable currency fluctuation). Recall back then in the month of April, TIV dropped by 23% YoY and 33% MoM given the consumers’ knee-jerk reaction to the implementation of GST. Subsequently, while May’s TIV saw a sequential improvement (+13% MoM), YoY sales remained soft at -8%, reflective of the weak consumer sentiment. Meanwhile on the currency side, MYR averaged at RM3.6597/USD during 2QCY15 vis-àvis 1QCY15’s RM3.6209/USD, which weakened by 1.1% against USD. Our sensitivity analysis suggested that for every 1% fluctuation in USD from our base case, UMW and TCHONG’s bottomlines could be affected by 3% and 6% respectively.

BJAuto still the best exposure. We remain selective in our picks and prefer companies 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 into 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 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 could translate into an attractive 7.3% dividend yield.

Source: Kenanga Research - 20 Aug 2015