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), August 2015 TIV recorded YoY growth of 5%, narrowing the negative gap of YTD8M15 TIV to -2% (from -3% previously) as opposed to our (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of 0.5% to register at 670,000 units). We view that the 5% YoY improvement was merely a rebound from the low base of August 2014 TIV. Recall that the weaker TIV back then was dragged down by the pallid sales of the two national marques due consumers holding back purchases prior to the launching of Perodua Axia and Proton Iriz. Moving into 4Q, we believe auto sales will gain momentum to make up for our flat TIV growth assumption; to be driven by aggressive A&P activities, festivities and stronger seasonal patterns. On the flip side, we believe all these catalysts will be at the expense of margins erosion. Another concern is the unfavourable exchange rates, particularly for 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 those are less vulnerable to the weakening 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, RM2.63) with investment merits backed by its: (i) better growth prospect from low base on the back of strong pipeline of exciting models, (ii) relatively stable margins, benefitting from the lower import duties from FTA with Japan, and (iii) potential dividend payout of 56%, which translate into c.5.7% dividend yield. Following recent share price weakness, the stock is currently trading at an undemanding 9.7x forward PER, which is at 21% discount to industry forward average PER of 12.2x.

Another disappointing quarter in 2QCY15. Out of the five stocks under our coverage, only MBMR and BJAUTO came in within expectations while UMW, DRBHCOM and TCHONG came in below expectations. Zooming into the underperformers, the main culprits were mainly the lower-than-expected margins from the vehicles and components price pressures (unfavourable currency fluctuations) and higher operating costs. Post-results, we have trimmed their earnings estimates to mainly account for higher advertising and promotional expenses as well as higher import cost. As a result, all their TPs were also trimmed but ratings maintained.

A pallid August TIV. While August 2015 TIV recorded YoY growth of 5%, narrowing the negative gap of YTD8M15 TIV to -2% (from -3% previously) as opposed to our (flat at 667,000 units) and MAA’s 2015 TIV growth assumptions (of 0.5% to register at 670,000 units), we view that the 5% YoY improvement was merely a rebound from the low base in August 2014 TIV. Recall that the weaker TIV back then were dragged down by the pallid sales of national marques due to holding back of consumer purchases prior to the launching of Perodua Axia and Proton Iriz. Meanwhile on MoM basis, TIV failed to extend its momentum after the Hari Raya festivities by registering a lower TIV of 53,452 units (-9%). Delving deeper into the passenger vehicles segment on YoY basis, both sales of national marques namely Perodua and Proton increased by 14% and 5%, respectively, from the low base effect mentioned above. Among the major non-national passenger marques, Nissan and Mazda were the strong performers which we believe they were mainly helped by their respective flagship models (Nissan: facelifted Almera plus new Nissan X-Trail; Mazda: Mazda 2). On YTD basis, sales growths of Proton and Toyota are still capped in the negative territory owing to the lack of attractive models launching.

Outlook in the 4Q2015. We believe auto sales will gain momentum in the 4Q, forming a stronger 2H which will 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 fullyear 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 4Q could very likely be at the expense of margins. Another concern is the 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 2Q15 results of both UMW and TCHONG where the higher CKD kits and CBU costs were the main culprits. Recall that c.1/3 of both group’s costs are denominated in USD with net impact to UMW relatively immaterial given the natural hedge from its USD revenue-denominated listed subsidiary, UMW Oil & Gas (90% derived from USD). Meanwhile on the currency side, MYR averaged at RM4.0536/USD during 3QCY15 vis-à-vis 2QCY15’s RM3.6597/USD, which weakened by 10.8% against USD. Our sensitivity analysis suggested that for every 1% fluctuation in USD from our base case of RM3.80/USD, UMW and TCHONG’s bottomlines could be affected by 3% and 6%, respectively. On the other hand, we view that BJAUTO should be protected from the adverse currency fluctuation for now as the group has a favourable hedging position from September to December at RM3.15/100 JPY currently. Recall that MYR averaged at RM3.3189/100 JPY during 3QCY15 vis-à-vis 2QCY15’s RM3.0160/100 JPY, which weakened by 10.0% against 100 JPY. For BJAuto, our sensitivity analysis suggested that for every 1% fluctuation of MYR vs 100 JPY from our base rate assumption of RM3.20/100 JPY, the fluctuation will affect BJAuto’s FY16E bottomline by 4%.

BJAuto still our pick for the sector. We remain selective in our picks and prefer players those 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 this category with investment merits backed by its: (i) better growth prospect from low-base on the back of strong pipeline of exciting models, (ii) relatively stable margins, benefitting from the lower import duties from FTA with Japan, and (iii) potential dividend payout of 56%, which translate into c.5.7% dividend yield. Moreover, we also see value emerging at this level (trading at a forward 9.7x PER, a steep 21% discount from the industry average forward PER of 12.2x) after the recent selldown. 

Source: Kenanga Research - 7 Oct 2015