We maintain our NEUTRAL rating on the AUTOMOTIVE sector. This stance is backed by the improvement in consumer sentiment gauge compiled by Malaysia Institute of Economic Research hovering at the c. 80pts-level in 3Q17, inching towards the optimistic threshold (>100pts). Additionally, the recent strengthening of the MYR against USD/JPY is expected to continue showing positive effects on automakers with gradual improvement in margin from a lower base. According to the Malaysian Automotive Association (MAA), YTD 11M17 TIV registered at 521,907 units (+1.3%), coming in within expectation at 88% of our TIV forecast at 590,000 (+1.7%). We expect sales volume for 4QCY17 to be the highest compared to other quarters owing to the year-end promotional events and higher registration for the all-new thirdgeneration Perodua Myvi (launched in mid-Nov 2017). Looking forward into 2018, we maintain our TIV estimates of 600,000 units with a limited growth of 1.7%. We believe the 2018 TIV will be fuelled by two sales themes namely: (i) value-for-money sales, focusing on affordable car variants, and (ii) segmental targeted sales, focusing on SUV segment. We chose BAUTO (OP; TP: RM2.30) as our preferred pick for the sector, backed by investment merits of: (i) solid earnings recovery with the launch of its flagship model, the all-new Mazda CX-5, (ii) superior margins, which is head and shoulders against industry peers (average profit margins of c.8% as compared to peers average at c.2%), and (iii) steady dividend yield of 5.1% with its net cash position, which accounts for 8% of market cap and strong 6% FCFE yield (FY18E).

Mixed performance in 3QCY17, as 2 out of the 5 covered stocks (UMW (MP; TP: RM5.30) and TCHONG (MP; TP:RM1.40)) performed below expectations while the remaining 3 stocks, (BAUTO (OP;TP:RM2.30),

DRBHCOM (MP;TP:RM1.80) and MBMR (MP;TP:RM2.20)) were deemed as within expectation. In 3QCY17 we observed; (i) slower auto sales for BAUTO, DRBHCOM, TCHONG, and UMW due to lack of new model launches and absence of major promotional activity to attract consumer demand, (ii) MBMR scored higher auto sales due to better promotional activity as well as higher sales of premium vehicles, (iii) 3QCY17 marked the first improvement in automotive division margin with the stronger MYR against major currencies (especially for USD and JPY), and (iv) new model launches closer to the end of 3QCY17, which is expected to translate into registration in 4QCY17. In this sector strategy, we upgrade TCHONG from UNDERPERFORM to MARKET PERFORM with unchanged TP of RM1.40 as we believe that its share price has reached a bottom given the YTD share price depreciation of 23%. Although, TCHONG still lacks of significant model launches to boost sales volume, it is expected to cushion its losses with the stronger MYR against USD given its 80% product costs exposure to USD.

Sales boosting year-end promotion in 4QCY17. We expect a boost in auto sales volume for 4QCY17 from the sales boosting year-end promotional activities and higher registration of the all-new third-generation Perodua MyVi (currently at 28k booking, c.8k delivered). The all-new Perodua Myvi (launched in mid-Nov 2017) is expected to benefit UMW (with its 38%-owned interest) and MBMR (with its 23.6%-owned effective stake), whereas BAUTO is expected to recoup its losses in sales volume with the launch of its flagship model, all-new CKD Mazda CX-5 (Launched in end-Oct 2017). However, we expect TCHONG to continue facing down-trending sales growth for the rest of the year with no indication of new significant models to boost volume.

Looking forward into 2018, we maintain our TIV estimates of 600,000 units (+1.7%). We believe 2018 TIV will be fuelled by sales themes namely: (i) value-for-money sales and (ii) segmental targeted sales. Value-for-money sales will be focusing on the affordable variants led by Perodua (Axia, Myvi, Bezza and Alza), followed by Honda (with its entry-level Hybrid segment, Jazz and City Sport Hybrid, as well as entry-level SUV segment, the BR-V). However, for the third place, there will be a competition between Proton (Saga, Persona and Exora) and Toyota (Vios, Hilux and Innova) with only 1% difference in market share. Whereas, for segmental targeted sales, 2018 will be the year of SUV segment led by the most anticipated introduction of ProtonGeely Boyue in 2H18, potential introduction of Perodua Kembara, all-new Toyota C-HR, 2018 Toyota Rush, all-new Mazda CX-8 and supported by the existing models of Mazda (all-new CX-5 and CX-3), Honda (BR-V, HR-V and CR-V) and Nissan (X-Gear and X-Trail). Note that, the all-new third generation Perodua Myvi (priced at RM44,300 to RM55,300) has been viewed as the most affordable car variants with advanced technologies (Advanced Safety Assist (ASA) and pre-built SmartTag toll reader) rivalling the non-national brands at double the price. The all-new Perodua Myvi is expected to be the number 1 selling car in 2018, which is expected to surpass its own Axia models and overtake the competition in the same segment (Proton Iriz, Honda Jazz, Mazda 2, Kia Rio, Ford Fiesta, Volkswagen Polo, and Peugeot 208).

Gradual improvement in margin, from strengthening of MYR against USD/JPY. The ringgit strengthened further to RM4.08/USD level for the month of December 2017 (as of 15th Dec 2017) from RM4.50 (end-2016) marking the strongest level reached in the past 11 months, which is already lower than Kenanga’s 2017 House estimate: RM4.15/USD. For comparison, 1QCY17/2QCY17/3QCY17 average USD/MYR level was at USD: RM4.45/RM4.33/4.26, respectively. On the other hand, for JPY/MYR, there are signs of improvement from the high of above RM4.00/100JPY for the year, to RM3.62/100JPY for the month of December 2017 (as of 15th Dec 17). For comparison, 1QCY17/2QCY17/3QCY17 average JPY/MYR level was at 100JPY: RM3.91/RM3.90/RM3.84, respectively. Overall, the unfavourable forex in 1HCY17 had dragged down the automotive division performance, which was, however, slightly cushioned by the recovery in 3QCY17.

From all the Auto players under our coverage, UMW (MP;TP:RM5.30) has the largest exposure to USD as all its imported completely knocked down (CKD) kits and completely built up (CBU) are from Thailand and with almost all transactions conducted in USD (every 1% change in USD impacts our FY18E NP by 4%). Secondly, TCHONG (MP; TP:RM1.40) is estimated to have 80% exposure to USD (of its imported costs where every 1% change in USD impacts our FY18E NP by 15%). Whereas, BAUTO (OP;TP:RM2.30) has 100% exposure to JPY and is the key beneficiary to the strengthening of MYR against JPY with its CBU imports, whereas CKD vehicles are purchased at a fixed rate from 30%-owned Mazda Malaysia Sdn Bhd (importer of Mazda CKD) which absorb any changes in JPY/MYR (every 1% change in JPY impacts our FY18E NP by 7%).

Bumpy sentiment expected in 4Q17, but still above 4Q16. The Malaysian Institute of Economic Research (MIER) 3Q17 consumer sentiment reading remains tepid at 77.1 pts (-3.6 pts QoQ, +3.5 YoY). We believe the downtrend is in line with the absence of seasonal factors during the quarter as the weaker spending would have translated to lower statistical results. Nonetheless, the record was better than 3Q16, likely from the lack of economic support from national sporting events. We believe 4Q17 may see another drag in sentiment with the cautious spending in school holiday season and selective spending based on sales promotion. However, general consumers remain optimistic about the economy since the index is expected to be above the 4Q16 index, which is the lowest in the last 6 quarters as well as on the expectation of healthier reading in 1Q18 on the back of Chinese New Year festivities and a potential general election to spur spending. Over the medium-term, our expectations are still soft unless a significant recovery in local currency rates emerge. Current index reading is still well below the “optimistic” level of 100.

YTD 11M17 TIV of 521,907 units (+1.3%), within expectation of our TIV forecast at 590,000 (+1.7%). We attribute the stronger YTD growth to the aggressive discounts and promotion for the purpose of inventory clearing of older line of vehicles, coupled with the roll-out of new models. Perodua continued to lead the pack with an unchanged market share at 35% and flattish sales growth. However, higher sales are expected with the higher registration of its all-new Perodua Myvi in Dec 2017. At the number two position, Honda’s performance in 11M17 is a significant improvement, with higher sales of 22%, and higher market share of 19% (11M16:16%) mainly due to the introduction of new models as mentioned earlier. Progressing further down the list, both Toyota and Proton saw increases in sales of 10% and 2% with market share of 12% (11M16: 11%) and 13% (11M16: 13%), respectively. On the other hand, brands that didn’t fare so well were Nissan and Mazda, with both facing sales declines of 32% and 24% with market share of 4% (11M16: 7%) and 2% (11M16: 2%), respectively. Mazda has started to recoup its losses in volume with the introduction of the all-new CKD Mazda CX-5 at end-Oct 2017, whereas Nissan is expected to continue seeing downtrend in sales growth for the rest of the year with no indication of new significant models to boost volume.

BAUTO (OP; TP: RM2.30) is our preferred pick for the sector. All in, we believe BAUTO may be a safer bet given its targeted customer base in the middle-income to high-income bracket that is less sensitive to the rising cost of living with investment merits such as; (i) solid earnings recovery with the launch of its flagship model, the all-new Mazda CX-5, (ii) superior margins, which is head and shoulders against industry peers (average profit margins of c.8% as compared to peers average at c.2%), and (iii) steady dividend yield of 5.1% with its net cash position, which accounts for 8% of market cap and strong 6% FCFE yield (FY18E).

Source: Kenanga Research - 5 Jan 2018