Dragged by oil and gas

Cautious outlook for near-term earnings. We cut FY16-18F earnings by 24%-70% after imputing lower auto sales due to increasingly competitive operating conditions, as well as further weakness in the oil and gas and others segments. We maintain our HOLD rating for UMW with a TP of RM5.30, based on SOP valuation. The group faces near-term earnings headwinds as its O&G business will be hurt by the sharp drop in oil prices, while the Toyota franchise wrestles with a challenging operating environment.

Dragged by O&G segment. The outlook for the O&G segment is looking gloomy, with six of its eight drilling rigs being warm stacked and only three with secured contracts, coupled with the fact that its short-term debt is piling up ? more than its cash and operating cash flow can cover. Its average rigs utilisation rate fell from 95% in 2014 to 52% in 2015.

Auto sales facing intense competition. Toyota and Lexus sales volume came in at 17,605 units in 3Q16 (+1.2% q-o-q; -26.0% y-o-y). We expect the 4Q16 sales outlook to remain dim because of intense competition amid a more challenging economic environment and weak consumer sentiment. Perodua?s 9M16 sales have also been low (-4.21% y-o-y), and the associate?s contribution is not sufficient to overturn lower earnings from Toyota.

Valuation

Maintain HOLD call. We maintain our HOLD rating for UMW but cut our SOP-derived TP to RM5.30. In our view, a recovery in O&G earnings and Toyota profit would be re-rating catalysts.

Key Risks to Our View

Sharp recovery in auto sales. Significantly stronger Toyota vehicle unit sales could revive earnings and re-rate the stock.

Source: Alliance Research - 29 Nov 2016