UMW has secured a second contract, from aircraft engine maker Rolls-Royce, worth RM1b over 15 years. The contract is for the supply of rear cases (vs. fan cases in the first contract). We are positive, but are mindful of potential start-up losses (as in the case of the previous Rolls-Royce job). We trim our FY23-24F net profit by 1.3% each, but raise our TP by 2% to RM4.80 (from RM4.70) as we now put a value to its aerospace segment (vs. none previously), encouraged by this recurring order from Rolls-Royce. Maintain OUTPERFORM.

Won RM1b contract. UMW has secured a second contract worth RM1b for 15 years from Rolls-Royce Holdings, a British aerospace company to manufacture a new line of rear cases for Trent 1000 and 7000 aircraft engines. Currently, the rear case is imported from overseas and assembled into a complete fan case. UMW Aerospace will be investing up to RM65m to set up the chemical milling and related processes to manufacture the rear case at its facility in the UMW High Value Manufacturing Park in Serendah. Due to strict non-disclosure agreement (NDA) between UMW and Rolls-Royce Holdings PLC, no details information was released by UMW.

Recall, UMW Aerospace secured the first contract in 2015 which is worth RM830m for 25+5 years to manufacture and assemble fan cases for Trent 1000 and Trent 7000 aircraft engines. It took two years to take off from ground zero to maiden delivery in 2017, breakeven at the EBIT level in 2019, and saw its first pre-tax profit in 2020 at RM1.7m. However, it slipped back to losses of RM33m in FY21 due to the pandemic lockdown. For 2022, UMW guided lower losses, which we estimated at RM22m, and UMW expects improved earnings with full borders re-opening in 2023/2024.

Impact to earnings. Based on the contract valued at RM1b to be awarded over 15 years, this translates into RM67m revenue per annum. Based on the previous contract timeline, we expect gestation period during the first three years of operations and only expect breakeven in the fourth year. Hence, we cut our FY23F and FY24F net profits by 1.3% each.

Previously, we did not attach any value to its aerospace segment as it was loss making solely from the maiden contract win from Rolls-Royce. However, the second contract reflects well for UMW’s credibility and operational efficiency. With the latest win, we are now putting a value to the aerospace segment given the recurring order from Rolls-Royce. As such, we revised our valuation methodology to Sum-of Parts (SOP) from PE valuation, valuing the aerospace segment using Price-to-Book valuation, and increase our TP by 2% to RM4.80 (from RM4.70). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

We like UMW for: (i) the mass-market marques under its automotive business, i.e. Toyota and Perodua, but not without high-margin models such as Toyota Vios and Perodua Alza, (ii) the strong earnings visibility at its automotive business backed by order backlogs of >250k units of vehicles, and (iii) it being a reopening play, given the pickup seen in its heavy/industrial equipment business and manufacturing of aero-engine fan cases. There is no adjustment to our TP based on ESG given a 3- star rating as appraised by us (see Page 4). Maintain OUTPERFORM.

Risks to our call include: (i) consumers cutting back on discretionary spending (particularly big-ticket items like new cars) amidst high inflation, (ii) supply chain disruptions, (iii) escalating input costs, and (iv) a global recession hurting demand for industrial/heavy equipment.

Source: Kenanga Research - 11 Apr 2023