Investment Merit

NHFATT will continue expanding into overseas market with the main focus on the ASEAN automotive market. Coupled with the recent land acquisition in Indonesia, this move could solidify the group's conviction in growing Indonesian market as a regional manufacturing hub. However, with the increasing cost of raw materials and gestation period for its Indonesian operations, we see limited upside at least for another two years. Not Rated with a Fair Value of RM3.40.

Forex gain reversed into forex loss. Recall that we had initiated the Trading Buy position on December 2016 (at RM3.78). Since then, it has continued to appreciate with capital gains of 8% to RM3.40 and registered strong earnings by +16% in FY16 to RM30.0m on the back of all-time high revenue, supported by the higher realised forex gain of RM7.3m, as well as a lower effective tax rate at 18.5% (FY15: at 27.5%) with the utilisation of reinvestment allowance. In its latest 9M17 results, although revenue increased by 11%, bottom-line (net profit decreased by 37% to RM12.8m) was hit by the forex loss of RM4.5m (9M16: forex gain of RM3.0m) and higher finance costs by 31% attributed to higher borrowings and debt balance from the inter-company loan to finance its Indonesia operations.

ASEAN automotive market as the main platform for expansion. NHFATT plans to increase its exposure in overseas market to 70% by 2021 (currently at 48%) with the ASEAN automotive market as the main platform based on the tremendous potential from AFTA trade liberalisation such as: (i) elimination of all import duties for ASEAN 10, and (ii) tapping a large 600m population base. Indonesia, registering almost double the Malaysian TIV numbers (at 1m new vehicles sold for FY16), has grown into one of NHFATT’s main export market with the increase in revenue for FY16 by 28% to RM8.2m or 1/3 of the ASEAN market segment. Correspondingly, NHFATT continues to increase its exposure in the Indonesian market with the recent land acquisition (at c.24,575 sq ft) by its wholly-owned subsidiary, PT. Auto Global Parts Indonesia SB valued at IDR54.1b (c.RM18.0m, excluding 10% value added tax). The land located at West Java, Indonesia, is slated for the future development of an auto parts manufacturing plant, which can shorten the lead-time and better cost competitiveness in delivering quality products to its customers in Indonesia. This is a part of the group's strategy to reduce reliance on its one and only manufacturing factory in Meru, Klang (utilization rate at c.70%).

Earnings expected to be compressed by higher raw materials cost. We are projecting lower earnings by 23% to RM23.0m for FY17 attributed to high raw materials cost (cold-rolled steel, as of 9M17, at USD680/MT from FY16, at USD500/MT and virgin plastic resin, as of 9M17, at RM9/kg, from FY16, at RM7/kg). Whereas for FY18, we project higher earnings by 6% to RM24.3m as we expect higher contribution from its Overseas Segment, as well as, implementation of price adjustments within the range of +2% to +3% on selected products to sustain the gross profit margin at c.27% level (FY16: c.29%), which is the same level for 9M17.

NOT RATED with a Fair Value of RM3.40 based on a 10.3x FY18E PER, which is at -0.5SD of its 5-year average mean in view of its limited upside in earnings attributed to the increasing cost of raw materials as well as the gestation period for its Indonesian operation. The ascribed valuation is at a discount to the FBMSC’s 2-year Fwd. PER of ~12x. Thus, we switch our Trading Buy call to Non-rated. We will review our call if there are significant earnings catalysts.

Source: Kenanga Research - 4 Dec 2017