• UMW Toyota targets to regain market share

• Non-listed O&G losses to narrow significantly from 1Q17

• FY17F raised to RM370m profit from RM52m loss previously

• Reaffirm BUY at a higher TP of RM6.50 (from RM6.00)

We re-affirm our BUY call at a higher TP of RM6.50/share (from RM6.00/share previously) after switching to an SOP based valuation given much better earnings visibility for UMW going forward. We attended UMW’s results briefing yesterday and came out more positive on prospects of UMW’s turnaround over the next two years.

Forecasts raised. We revise up our FY17F to a net profit of RM370m vs. a RM52m loss previously and introduce our FY18F net profit of RM568m. This is still conservative relative to UMW’s RM800m-RM1b earning prior to this downcycle. This is on the back of stronger than expected auto earnings in its FY16 (key earnings driver going forward, 80% of core, non-O&G earnings), much lower non-listed O&G losses going forward and conservatively assuming half a year consolidation of UMWOG losses – even though the disposal exercise is targeted to be completed in Apr17. Our forecasts are now 36%/37% higher than consensus over FY17F/18F.

Non-listed O&G losses will narrow significantly. The non-listed O&G assets (which UMW will carry until full disposal targeted by end FY17F) will see a significant narrowing in losses from next quarter following massive impairments in 4Q16. Those that have ceased operations have been impaired down to zero carrying value, while the companies that are still in operations/have been scaled down have been impaired down substantially which will reduce depreciation and operational losses. UMW’s option to exit O&G is not limited to just selling companies but selling the units on a piecemeal, asset-by-asset basis. As some of these have been impaired down to zero, any sale will result in gains going forward. We estimate operational losses to reduce by a third in FY17F vs. the RM160m-170m annual losses previously.

Targets to regain market share in FY17F. Management is forecasting Toyota+Lexus volumes to rise 8% to 70K units in FY17F, well outperforming industry growth of 2% and underpinning our view of a reversal in Toyota’s multi-year market share loss since FY14. A key catalyst is the new EEV qualified Vios launched in Oct16, which is priced up to 4% cheaper but yet entails an expansion in margin-per-model given EEV duty rebates enjoyed. Notwithstanding a stronger USD, FY17F will reflect a full year impact of this margin expansion.

Large part of forex hit already taken in FY16. One of our concerns for UMW autos in FY17F previously was the strength of the USD. This is considering that spot average rates stood at USD:RM4.14 in FY16 versus current spot rates of USD:RM4.44 (or an average USD:RM4.30 we have assumed in our FY17F forecast), which imply a sharp 7% increase. However, our checks with management yesterday suggested that UMW Toyota (UMWT) actually incurred USD rates of RM4.29 – RM4.35, or a simple average of RM4.31. Relative to our FY17F average of USD:RM4.30, the change will be minimal as the high forex incurred last year means that UMW had already taken the hit from the strengthening of the USD in FY16. More importantly, despite incurring the inflated forex rates, UMW autos still generated a net profit of RM300m in FY16. The deviation between UMW’s forex cost in FY16 relative to average spot rates can be attributed to timing of physical inventory purchases, which will differ player to player. This is especially so, since the bulk of UMWT’s volumes last year came towards the 4Q, which was when the USD had already strengthened significantly against the Ringgit.

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 (MIDFR forecast: +13%yoy) off a weak base in FY16 and vs industry growth of 2%.

Core businesses remained profitable. Excluding the RM1.3b O&G asset impairments and an additional RM900m provision for a financial guarantee for its Indian operations, UMW’s core businesses i.e. autos / equipment / M&E would have registered solid pretax profit of RM671m and a net profit of RM414m in FY16, with autos contributing the bulk of this (72%) at RM300m. UMW’s earnings turnaround will be two-pronged, driven by the O&G exit and growth in the core segments, especially autos and aerospace.

Recommendation. We reaffirm our BUY call on UMW and raise our TP to RM6.50/share (from RM6.00/share) as we switch to an SOP based valuation (vs. BV based previously) given much improved earnings visibility post disposal of O&G, and given the upward revisions to our earnings forecasts in this report. From a valuation standpoint, UMW is cheap at 11x FY18F earnings, relative to historical valuation of >12x in the past 10 years.

Source: MIDF Research - 1 Mar 2017