• 4Q16 earnings marred by one-off O&G asset impairments.

• O&G units underperformed but non-O&G outperformed.

• O&G underperformance now less relevant with disposal in next 2 months.

• Maintain BUY at unchanged TP of RM6.00. Forecasts under review with upside bias.

4Q16 hit by asset impairments. As we had forewarned in our 3Q16 results note, UMW’s 4Q16 was a kitchen sinking quarter. Excluding a total of RM1.3b of impairment losses (RM780m from UMWOG and RM380m for non-listed O&G units), UMW registered a core net loss of RM283m for its 4Q16, which brought FY16 core net losses to RM402m. The underlying net loss was still deeper than both our and consensus expectations, but the underperformance came mainly from the O&G division, which will soon be disposed of.

O&G underperformed, non-O&G outperformed. Despite Toyota registering its worst TIV in more than a decade in FY16, UMW autos still managed to garner a net profit of RM300m in FY16, while equipments registered a net profit of RM115m, which far exceeds our earlier estimates of a total RM280m net profit for non-O&G units. Autos is supported by strong Perodua sales given launch of the Bezza in Jul16 while Toyota sales improved substantially in 4Q16 (11%qoq) after launch of the new Vios in Oct16

Underperformance of UMWOG now less relevant. The key underperformance in 4Q16 came from the O&G units, particularly UMWOG (listedco) - the Naga 1 which is UMWOG’s only semi-sub rig was idle was idle throughout 4Q16 while new jobs for its jack-up rigs to make up for the shortfall will only be reflected gradually over the next few quarters. With the disposal of UMWOG by early 2Q17 however, the deeper than expected losses are now less relevant to our forecasts as any downward revision would be limited to circa a quarter of contribution while upward revision of non-O&G will be reflected for the full year. The non-listed O&G units’ loss of RM160m was more or less similar to FY15. On the bright side, losses from the non-listed O&G units should narrow in FY17F as depreciation should lower significantly post the 4Q16 impairments.

Accelerating the inflection point in earnings. Ex-O&G, UMW would have made hefty net profit of RM414m in FY16 (see Exhibit 2) vs the reported RM1.2b net loss. Disposing the O&G units accelerates the turnaround in UMW’s earnings instead of having to wait a couple more years for the O&G units to turnaround, if it were to happen.

Where the recovery for autos will come from? Toyota was at its weakest in its model cycle in FY16, market share has been hit in the past few years due to cost disadvantage against main rival Honda (pricing had to be raised much more than Honda in early FY16 to manage inflated import cost from the weak Ringgit) and Toyota TIV of ~65k in FY16 was its lowest in the past decade. Introduction of the new Vios, which is not just Toyota’s best-selling model (accounts for 30%-40% of Toyota TIV) but also qualifies for EEV (Energy Efficient Vehicle) incentives, kills two birds with one stone in the sense that it will re-accelerate market share recovery and allow Toyota to gain a more competitive cost base given a significant reduction in duty cost for this model (See report dated 23rd Feb 2017 for more details). Toyota is expected to be one of the best performers in terms of volume growth this year (+19%yoy) off a weak base in FY16 and vs industry growth of 2%.

Recommendation. Our BUY call, TP of RM6.00/share and forecasts are maintained (with upside bias) pending an analyst briefing this morning. Given outperformance of the core non-O&G units and improved visibility post-O&G exit, a switch to an earnings based valuation looks more relevant now.

Source: MIDF Research - 28 Feb 2017