We came back from UMW’s Aerospace Rolls-Royce fan case manufacturing plant visit with our cautious view unchanged due to the group’s mixed prospects. Maintain MARKET PERFORM with a higher TP of RM6.25 based on revised 20x FY18E EPS (from RM5.30, based on 17x FY18E EPS) premised on potential growth in the next two years.

The 25+5 years agreement with Rolls-Royce PLC. UMW Aerospace Sdn Bhd has signed a 25+5 years agreement with Rolls-Royce PLC in 12th August 2015 (we have factored in RM750m CAPEX allocated for the first 2.5 years) to manufacture and assemble fan cases for Trent 1000 and Trent 7000 aero engines. The manufacturing plant is located in Serendah, Selangor and tailor-made to support the Rolls-Royce engine assembly plant in Seletar, Singapore, which is in line with Rolls-Royce’s strategic intent to build a supply chain in the Asia Pacific region. With this agreement, UMW Aerospace became the first Malaysian company to be a Tier-1 aerospace engine component manufacturer.

Expected breakeven point in 2019. UMW Aerospace has delivered 6 fan cases for 4Q17 and additionally, expects to ramp up its production to 80 fan cases for 2018 and 160 fan cases by 2019 before hitting full capacity of 250 fan cases by 2020.UMW Aerospace is expected to be profitable at 160 fan cases level in 2019 considering that some frontloaded investments need to be amortised. The full production capacity is in line with the full production capacity of Seletar Rolls-Royce engine assembly plant.

Double-digit revenue growth for UMW Aerospace envisaged over the next 5 years. UMW Aerospace expects to post double-digit revenue growth over the next 5 years. However, due to the stringent contract condition with Rolls-Royce PLC, the company is unable to disclose the information regarding the average selling price or the costs breakdown for the fan cases. Based on 9M17 results, the M&E segment posted pretax losses of RM13.2m and we estimated that UMW Aerospace has incurred start-up losses of c.RM47.1m (given that other business in M&E segment remained at the same level as of FY16). We have factored in the start-up losses in FY17E reported NP while maintaining FY17E CNP numbers.

Outlook. We maintain our neutral stance on UMW in view of the singledigit growth in its automotive segment sales volume pending the completion of its new Bukit Raja Plant (expected to be operational in early 2019, an additional 50k capacity (one-shift) to the current 75k) and the gestation period for its Rolls-Royce plant (expected to break even in FY19). Moving forward, the group’s strategic exit from the O&G industry is expected to improve the group’s profitability. Furthermore, the automotive segment is expected to be driven by the new models namely 2018 Toyota C-HR CBU, 2019 Toyota C-HR CKD, 2018 Toyota Harrier, all-new Perodua MyVi and face-lifted variants of existing models.

Maintain MARKET PERFORM with a higher TP of RM6.25 based on the revised 20x FY18E EPS implying +1.0 SD of its 5-year mean historical PER (previously from TP of RM5.30 based on 17x FY18E EPS implying 5-year mean PER). We believe our valuation level is fair considering the higher net profit growth over the next two years (>100%) partly from the elimination of losses from its Oil & Gas division (c.RM213m), as well as expected higher car sales volume and improvement in margin from the stronger MYR against USD. Additionally, UMW envisaged double-digit revenue growth for UMW Aerospace in the next 5 years. Risks to our call include: (i) changes in car sales volume, and (ii) changes in forex.

Source: Kenanga Research - 10 Jan 2018