• Core earnings expanded further in 2Q17

• Four launches by UMW Toyota from next month, coupled with stronger Ringgit

• Trim FY17F/18F earnings slightly to factor in higher fan case plant pre-operating expense

• Reaffirm BUY at unchanged TP of RM7.20/share.

Earnings expansion. After returning to the black in 1Q17, UMW registered further core earnings expansion to RM27m in 2Q17 (+35%qoq). This brought core earnings to RM47m in 1H17, excluding heavy non-operational items: (1) RM127m one-off accounting loss on demerger of UMWOG (2) RM40m one-off redundancy expenses on cessation of drilling operations in Oman (3) ~RM69m Sukuk drawdown charges. From 3Q17, earnings should improve significantly from absence of UMWOG losses. Expect further improvement in auto earnings against the seasonally weak and peak USD in 1H17 and driven by new launches in 2H17. However, the 1H17 core earnings were a tad below expectations due to higher than expected pre-operating expense from UMW’s new fan case plant.

Relooking at fan case plant pre-op losses. Our chat with management yesterday suggests pre-operating expenses from the fan case manufacturing plant (to commence supplies to Rolls Royce from 4Q17) could be larger than our earlier estimates. We trim our FY17F/18F by 7%/10% to factor in a loss run-rate of ~RM14m/quarter from the plant, before turning profitable in FY19F.

Autos improved further. Auto pretax earnings improved 14%qoq on the back of a stronger Ringgit and volume improvement (+4%qoq) (+1%yoy). 2H17 should strengthen further with new launches i.e. facelifts of Vios / Fortuner / Hilux / Camry commencing next month – these models account for >70% of Toyota TIV. The Ringgit has strengthened further to USD:RM4.26 levels from USD:RM4.33 in 2Q17.

Meaningful launches in FY18. The much awaited CH-R and the all new Camry are likely to be introduced in FY18F. Our recent visit to a CHR showbooth at PNB suggests a possible 3Q17 launch of the CBU-spec CH-R, to be available in two specs i.e. 1.8 litre and 2 litre hybrid with indicative initial import batch of 500 units. However, the first round of showcase at Setia City Convention Centre in May already generated registration of interest by over 3,000 potential buyers. CKD of the CH-R is likely after UMWT’s Bukit Raja plant is completed by early FY19F, which could bring down cost of the CH-R substantially. Perodua is expected to launch the new MyVi towards year end and underpins stronger FY18F numbers (accounts for an estimated 37% of group bottomline).

FY17F earnings to be backloaded. As we had highlighted before, FY17F earnings will be back loaded given: (1) Elimination of UMWOG losses in 2H17 (2) Peak USD in 1Q17 (3) Seasonally stronger volumes in 2H, especially 4Q which historically accounts for 30%-35% of full year TIV (4) Four new launches in 2H17, commencing next month.

Reaffirm contrarian BUY at unchanged TP of RM7.20/share. Key catalysts: (1) Demerger of O&G units

deleverages balance sheet, drives UMW back into the black and allows better focus on core divisions (2) Reversal of prior years’ market share loss, structural cost reduction and pricing advantage from UMW Toyota’s EEV-focused strategy (3) Redevelopment of UMW’s 711 acres Serendah land which will unlock value of the asset – easily worth 39sen/share on our estimates (4) A more than quadrupling of M&E division earnings once its aerospace division reaches full scale production

Source: MIDF Research - 29 Aug 2017