Reiterate OVERWEIGHT. The sector’s 4QCY22 results were mixed with most players under our coverage dragged by high input costs. Nevertheless, the worst of margin squeeze is over as: (i) the high-cost inventories will be depleted over the next 3-6 months as production ramps up, and (ii) prices of commodities and key components had since softened. Our projection implies that 2023 TIV will sustain at the record 2022 level of 720k units versus a more conservative forecast of 650k (-9.8%) by the Malaysian Automotive Association (MAA) underpinned by: (i) a pause in OPR hikes, (ii) stable new car prices, thanks to the deferment of new excise duty regulations (that could have resulted in prices of locally assembled vehicles increasing by 8%-20%), and (iii) a healthy industry booking backlog of 350k units as at end-Jan 2023 (which is nearly half of our 2023 TIV projection of 720k units). Our sector top picks are MBMR (OP; TP: RM4.60) and UMW (OP; TP: RM4.70).

High production cost. The recently concluded 4QCY22 results season saw a slight QoQ deterioration in performance for automotive stocks under our coverage, weighed down by high production. Against expectations, 50% of the results was within and 50% below versus 17% above and 83% within for 3QCY22. BAUTO, DRBHCOM, and SIME performed within expectations whilst MBMR, UMW and TCHONG underperformed on higher-than-expected cost of production. Both MBMR (OP: TP cut by 4% to RM4.60 from RM4.80) and UMW (OP: TP cut by 5% to RM4.70 from RM4.95) were affected by the weaker-than-expected showing from manufacturing associate Perusahaan Otomobil Kedua Sdn Bhd on higher input costs despite record sales volume recorded in the fourth quarter. Nevertheless, during results briefing, both MBMR and UMW believe the worst of Perusahaan Otomobil Kedua Sdn Bhd’s margin squeeze is over as: (i) the high-cost inventories will be depleted over the next 3-6 months as production is ramped up to full capacity, and (ii) prices of commodities and key components had since softened. On the other hand, TCHONG (UP: TP cut by 6% to RM0.80 from RM0.85) plunged deeper into the red losing to competitors which flooded the market with attractive new models and its inability to raise prices to pass on rising production cost.

Upbeat on sales volume. Looking forward, we project a more upbeat 2023 total industry volume (TIV) target at 720k units (+0%), compared to MAA’s 650k (-9.8%), premised on strong reception to new models (at higher prices, resulting in better margins for auto players), a pause in the OPR hike and the deferment of new excise duty regulations resulting in stable car prices. In comparison, MAA is more cautious on the industry outlook as a whole, especially for the low-end segment, (we believe) due to the impact of high inflation on the low-income group especially with the rising cost of basic necessities.

An encouraging sign to note is that the backlogs booking raced up to the tune of 350k units (as at end-Jan 2023) which is higher than 300k units three months ago, indicating strong order replenishment especially for attractive new models (see page 3) even in the absence of SST exemption. Additionally, vehicle sales will be supported by new battery electric vehicles (BEVs) which will enjoy SST exemption and other EV facilities incentives up to 2025 for CBU and 2027 for CKD.

Our sector top picks are:

• MBMR for: (i) its strong earnings visibility backed by an order backlog of Perodua vehicles of 220k units, (ii) it being a good proxy to the mass-market Perodua brand given that it is the largest dealer of Perodua vehicles in Malaysia, as well as its 22.58% stake in Perusahaan Otomobil Kedua Sdn Bhd, the producer of Perodua vehicles, and (iii) its Tier-1 OEM auto parts manufacturing certification.
• UMW for: (i) the mass-market marques under its vehicle dealership business, i.e. Toyota and Perodua, but not without high-margin models such as Perodua Alza and Toyota Veloz, (ii) strong earnings visibility at its vehicle dealership business backed by order backlogs of >250k units of vehicles, and (iii) it being a reopening play, given the pick-up seen in its heavy/industrial equipment business and manufacturing of aero-engine fan cases.

Source: Kenanga Research - 10 Mar 2023