INVESTMENT THESIS

• 2Q18 earnings up sequentially despite temporary margin impact from CX5 run-out

• Declares 1.6sen/share interim dividend; 83% payout

• Expect full swing recovery in 2H18

• TP revised marginally to RM2.50 but BUY re-affirmed. 5% dividend yields attractive

Sequential earnings improvement. BAuto reported net profit of RM22m for its 2Q18, which brought 1H18 earnings to RM42m. A 1.6sen/share interim dividend was declared representing 83% payout; slightly higher than our 80% assumption (FY18F). Though the gap-up in BAuto’s earnings is expected only from 3Q18 onwards, BAuto’s 2Q18 nonetheless, registered a 10%qoq improvement given 1-month contribution from the new CX5.

But this is offset by additional dealer incentives of up to RM12K per unit for run-out of the old CX5. 457 units of the old CX5 was sold in 2Q18 while 860 units of the new CX5 were booked-in in the period. Additionally, associate earnings (comprising manufacturing and export operations) has yet to reflect the re-acceleration in production and commencement of exports from Oct17 and Nov17 as the 2Q18 captured only Jul-Sep figures. A weaker Peso in 2Q18 also had an impact on BAuto Philippines’ (BAP) operations - accounts for 11% of earnings.

Backloaded earnings. Based on our chat with management last Friday, BAuto is keeping its 12.5K domestic volume target for FY18F, which means 60% of FY18F TIV is expected to come in 2H18. Additionally, EBIT margins are expected to improve in 2H18 vs. the depressed 7.5% in 1H18 given further RM strength and reduced impact of CX5 run-out. Outstanding bookings for the new CX5 stands at 750 units with more than half going for the premium priced special colors and ~30% for higher spec variants i.e. 2.5 litre 2WD GLS and higher.

What will drive the earnings gap-up in 3Q?:

(1) We estimate RM5.5m spent in additional dealer incentives for runout of the old CX5 in 2Q18 – this should reduce significantly in 3Q18 as there is only 200 units left to clear

(2) The RM gapped up to RM3.62:JPY now from RM3.83:JPY average in 2Q18 – this will result in an estimated RM10m/quarter incremental earnings

(3) Full quarter contribution of the new CX5 vs. only one month contribution (860 units) in 2Q18

(4) Re-acceleration at manufacturing units (captured at associate line) from launch of the new CX5 and commencement of exports to Indonesia, Philippines, Cambodia and Thailand. Production rate has now more than tripled to 2,000units/month vs. just 600units/month in 1H18.

Having said that however, we are enticed to trim our FY18F by 12% to factor in the larger than expected cost for runout of the old CX5 in 1H18 (which is a temporary and a one-off event) and as we fine-tune our TIV forecast closer to management’s guidance. Our FY19F earnings however remains intact and earnings adjustment does not de-rail our investment case for significant improvement in earnings at BAuto over the next 2 years driven by: (1) Re-acceleration of Mazda TIV growth in Malaysia and Philippines driven by new launches, (2) A re-acceleration of manufacturing earnings driven by export market expansion and new models (3) A strengthening Ringgit against the JPY.

Recommendation. From a valuation standpoint, BAuto is cheap at just 11x CY18F earnings, relative to historical sector PE of ~12x, while dividend yield of 5% is attractive. Given a solid 41% earnings CAGR over the next 2 years, solid dividend yields and value unlocking from the listing of BAP, BAuto should in fact trade at a premium to the sector. Our TP is revised marginally to RM2.50/share (from RM2.55/share) given the FY18F earnings tweak but our BUY call is re-affirmed. Key share price catalysts in the next 12 months:

(1) A 20%yoy FY18F Mazda TIV growth coupled with margin expansion driven by the new CX5 from 3Q18

(2) Ringgit strength 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 export market expansion to South East Asia (ex-Vietnam) and re-acceleration in production for the domestic market.

(4) Attractive dividend yield of 5% underpinned by net cash which accounts for 12% of market cap and solid 6% FCFE yield (FY18F). Potential listing of Philippines unit will bump yields up further given possible special dividends.

(5) Value unlocking from the listing of BAuto Philippines (BAP). Current market cap attributes just 7x CY18F PE to BAuto’s stake in BAP relative to the 15x 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 Dec 2017