UMWC has entered into an agreement with Komatsu Ltd to establish a JVC consisting all of UMWC heavy equipment subsidiaries. Subsequently, UMWC will sell a 26% stake in the JVC to Komatsu Ltd for RM133.9m cash which works out to a PER of 11.4x which is considered fair compared to Sime Darby Industries’ Fwd. PER of 12x. We are positive on this news as the formation of the JVC will further strengthen the long-standing relationship (53 years) with Komatsu. Maintain MP with an unchanged TP of RM6.50.

JVC formation for heavy equipment business. Following the Letter of Intent on 29th August 2017, UMW Holdings Bhd wholly-owned, UMW Corporation Sdn Bhd (UMWC) had on 2nd July 2018 entered into an agreement with Komatsu Ltd (Japan) to establish a joint venture company (JVC) consisting all of UMWC heavy equipment subsidiaries, which are involved in the heavy equipment business in Malaysia, Brunei, Myanmar, Papua New Guinea and Singapore. Subsequently, UMWC will sell a 26% stake in the JVC to Komatsu Ltd for RM133.9m cash and the remaining 74% shareholding will continue to be held by UMWC. The parties will enter into a Joint Venture Agreement (JVA) at a later date to set out their mutually agreed rights, duties, liabilities and obligations in relation to the operations of the JVC. The proposed transaction is expected to be completed by 31st December 2018.

Divestment PER of 11.4x is fair compared to Sime Darby Industries’ Fwd. PER of 12x. For illustrative purposes, based on FY17 equipment segment’s net profit of RM112.5m (where heavy equipment accounted for 40% of profit based on our back-of-the-envelope calculation), the 26% divestment in the JVC works out to a PER of 11.4x, which we considered fair compared to our ascribed Sime Darby Industries’ Fwd. PER at 12x or Caterpillar’s Fwd. PER of 15x. For illustrative purposes, based on our estimates, earnings leakages from this divestment is at c.2% of our FY19E net profit. Note that, heavy equipment business contributed 40% of revenue to the UMWH group equipment segment (equipment segment is at 14% of the group total revenue).

Rationale. The JVC formation is to further strengthen and expand market penetration of Komatsu products in Malaysia, Brunei, Singapore, Myanmar and Papua New Guinea. The proposed collaboration is also intended to boost sales by capturing new growth segments with the introduction of new products to meet customer demand.

Outlook. With the zero-rated GST starting 1st June 2018 (at an average price reduction of c.6%), we expect a boost in car sales during this tax holiday transition period, while the expected introduction of the SST may increase car prices depending on the new mechanism. In 1Q18, the group has launched two new models namely the all-new Toyota CH-R, and all-new Toyota Harrier, whereas, in 2H18, the group will launch Lexus models (LS, RX350L & Lexus NX300) and all-new Perodua SUV D38L. On the other hand, the strategic exit from the O&G industry is expected to improve the group’s profitability with a more solid balance sheet. Nonetheless, we maintain our neutral stance on UMW in view of the limited growth in car sales pending the completion of its new Bukit Raja plant (expected to be operational in early 2019), and gestation period for UMW Aerospace.

Keeping our FY18E/FY19E earnings unchanged. We keep our FY18E/FY19E earnings and TP unchanged at RM6.50 as we have sufficiently accounted for equipment business contributions in our assumptions. Our current valuation is based on 20x FY19E EPS implying +1.0SD of its 5-year historical mean PER. Maintain MARKET PERFORM. Risks to our call include: (i) lower-than-expected car sales volume, and (ii) unfavourable forex.

Source: Kenanga Research - 3 Jul 2018