UMW will demerge its subsidiary, UMWOG, with a Proposed Distribution through the Proposed Bonus Issuance of 1,204m RPS. Subsequently, Proposed Redemption of all the RPS at a premium in a form of UMWOG shares. Thus, we increased our FY17E earnings estimate but leaving FY16 estimate unchanged for now as demerger will only commence on April 2017. Upgrade to OUTPERFORM with an increased TP of RM5.28 on PER of 12x on FY17E EPS.

Demerger via Distribution in Specie. The company will undertake the Proposed Distribution (scheduled on April 2016) through the Proposed Bonus Issuance of 1,204m redeemable preference shares (RPS) of RM0.01 each on the basis of c.1.03 RPS for each existing shareholding as of the entitlement date scheduled on March 2017. At this juncture, the redemption price of the RPS has yet to be determined and is not transferable.

The Rationale of the Distribution. The proposed Demerger is in line with UMW’ plan to exit the O&G industry, through its shareholding in the UMWOG Group as well as through assets held by UMW for onshore drilling services, manufacturing of oil country tubular goods (OCTG), anti- abrasion coating services for OCTG and several others practicalities. Management commented that these assets will be subjected to impairment, where the quantum of its impairment will be in accordance to results from the group’s annual audit impairment testing exercise on a later date.

We are positive towards this development as we expect an uplift in earnings with the elimination of heavy weighted items, as part of the UMW group’s O&G segment, such as depreciation incurred from the O&G segment and suppressed operating margins due to low rig utilisation. As O&G segment incurred high borrowings, following the demerger, UMW balance sheet is set to improve with net gearing of 0.5x in FY17 from 0.7x in FY16. Post demerger, we anticipate for a better profitability, hence we upgrade our FY17E earnings to RM513.6m (+c.200% revision). We make no revisions to our FY16E earnings as the proposed demerger shall only be implemented in April 2017.

Although shareholder sentiment is likely to improve with the proposed demerger, the near-term outlook for the Automotive Segment remains soft, evident from the weaker combined total sales from Perodua and Toyota at 251k units in FY16 as compared 278k in FY15. This is also attributed to the higher base in Dec 2015 where there were heavy pre- emptive purchases in view of price hikes implemented by most auto players in Jan 2016, further aggravated by tighter lending policies. Moving forward, dragged by higher operating costs from marketing and high import cost on unfavourable currency fluctuations, we estimate flattish growth on combined sales increase at 254k units in FY17 due to lacklustre demand as we continue to believe that margins will remain subdued.

Upgrade to OUTPERFORM (from UNDERPERFORM) with an increase TP of RM5.28 (from RM4.27, previously). We change our valuation methodology from SoP valuation to an applied 12.0x PER to our revised FY17E EPS of RM0.44, where earnings are exclusive from O&G segment earnings, which was valued at 0.5x PBV separately. We believe the re- rating of the stock presents a fair opportunity to shareholders, as the prevailing price weakness could be attributed primarily by the unfavourable O&G performance in prior years.

Source: Kenanga Research - 20 Jan 2017