• New CX5 is a volume and margin catalyst from Sep17

• Exports volume expansion from Oct17

• Near-term, run-out of current CX5 may dampen margins

• Re-affirm BUY but tweak TP down to RM2.55 (from 2.60)

We visited Inokom’s assembly plant in Kedah yesterday with a group of 13 clients. Present at the meeting were Inokom’s Managing Director, En. Rizal Jailani and his management team, Ikehara-san from Mazda Japan, as well as BAuto’s management, Dato Francis Lee and Dato Amer Hamzah. Below are key takeaways from the meeting:

New CX5 launch on track. BAuto is on track to launch the new CX5 in the final week of September 2017 as per earlier plans. The CX5 is BAuto’s bread-and-butter model, accounting for 43% of volumes. Production of the new CX5 has started with actual ramp-up to commence from end-August. BAuto is targeting to build up 400-500 unit inventories of the new CX5 prior to actual launch ito minimise waiting time. Earlier chat with management suggests target sales of ~5K units a year (circa 417 units/month). The last few units of the current generation CX5 will roll off the lines this week as gradual expansion of lines for the new CX5 takes place. Circa RM20m capex has been put in for the new CX5 production lines with a 2 year expected payback. MMSB has allocated around 19K/annum capacity for the CX5, including export capacity. A 2nd Mazda paintshop has been completed which will produce 3 special colors for the new CX5 i.e. Soul Red Crystal, Machine Grey & Snowflake White Pearl, while the rest of the colors are painted at the original Mazda paintshop.

Better margins? The new CX5 entails 40% localisation rate, similar to the current generation, which means duty costs will remain the same. However, pricing will be raised by RM2K-3K which will translate into improved margins. Still, even at the revised pricing, the CX5 remains well more competitive than Japanese peers. Current generation CX5 is priced at a range of RM131K – RM165K OTR without insurance (compared to the CRV’s RM142K - RM168K). On top of this, the special color variants for the CX5 will also command an additional RM2K-RM3k price premium. This means the new CX5 will be both a volume (FY18F: +30% yoy) and margin kicker for BAuto from 2QFY18.

Export hub. Export of the new CX5 will commence from October 2017. Immediate export markets will be Thailand and the Philippines followed by Indonesia and the rest of South East Asia ex-Vietnam. To recap, BAuto, through 30% owned Mazda Malaysia Sdn Bhd (MMSB) has secured the rights from Mazda Japan to expand exports of the CX5 to the whole region versus just Thailand for the previous generation CX5. All exports will be denominated in JPY, which will provide a natural hedge against BAuto’s and MMSB’s JPY denominated imports. Management noted that no additional cost is required for the assembly of LHD vehicles to be exported. Export volumes can almost triple the 5K units achieved in FY17A given the export market expansion MMSB contribution to group should double to 16% in the next 2 years.

Earnings revision. We tweak our FY18F earnings down slightly by 2% to reflect the impact of the CX5 run-out. This is partly offset by upward revisions to pricing of the new CX5 (we assume an average 2% increase). FY19F remains intact as the impact of the CX5 run-out is expected to be temporary.

Recommendation. Post earnings revision, our TP is tweaked lower to RM2.55/share (from RM2.60/share), but BAuto remains our top sector pick. From a valuation standpoint, BAuto is trading at an undemanding 10x CY18F earnings, relative to historical average of 13x. Given a strong 41% earnings CAGR over the next 2 years, solid dividend yields and value unlocking from the listing of BAP, BAuto is slated of a re-rating. Key share price catalysts in the next 12 months:

(1) A 30%yoy growth in FY18F Mazda TIV coupled with margin expansion driven by the new CX5 in Sep17

(2) Strength of the Ringgit against the JPY

(3) A more than doubling in associate earnings contribution to group (via 30%-owned Mazda Malaysia SB and 29%-owned Inokom) given a massive export market expansion which will triple MMSB’s prospective market.

(4) Attractive dividend yield of 8.6% underpinned by net cash which accounts for 12% of market cap and solid 7% FCFE yield (FY17F). Listing of Philippines unit will bump yields up further given potential one-off special dividends.

(5) Value unlocking from the listing of BAuto Philippines (BAP). Current market cap attributes practically no value to BAuto’s stake in BAP relative to the 16x indicative IPO valuation and historical sector valuation of 12x (for Malaysian autos). Ex-cash, BAuto trades at just 9x CY18F earnings.

Source: MIDF Research - 11 Aug 2017