INVESTMENT THESIS

• Mazda TIV could test historical high

• CX5 pricing raised across the board

• We estimate >50%qoq improvement in 3Q18 earnings

• Re-affirm BUY at higher TP of RM2.70, 7% dividend yields attractive

Pricing raised. Pricing for the new CX5 has been raised by RM1K across the board from Jan18. We estimate this will impact annual earnings by ~2% based on our conservative FY19F CX5 volume of 6K units. This is likely to trickle through meaningfully from 4QFY18.

Volumes likely to test record high. Despite the price hike, Mazda’s Jan18 TIV could test historical high levels of 1300-1400 units as orders resume moving into the new year and given strong demand for the new CX5. We estimate BAuto’s 3QFY18 TIV at 3K units, up 19% sequentially and a whopping 37%yoy. Outstanding bookings of the new CX5 currently stand at >900 units. More importantly, the strong TIV will come with improved margins given the price hike for the CX5 in Jan18 and minimal discounting. Half of the new CX5 sales are for special colors which are priced at RM2000 premium.

Associates benefit from higher production. Associate earnings comprising 30%-owned Mazda Malaysia Sdn Bhd (MMSB) and 29%- owned Inokom have been dismal in the past 2 quarters given low production and run-out of the old CX5. According to management, BAuto’s 1HFY18 associate earnings only reflect Jul17-Sep17 contribution prior to the new CX5 launch in Nov17. We expect this to improve from 2HFY18 driven by launch of the new CX5 and commencement of exports of the same model to Thailand, Indonesia and Philippines. We gather CX5 export rate to Thailand is now ~1K units/month (vs. negligible amounts throughout 1HFY18) while production for Malaysia is at 900/month. At this rate we estimate total MMSB production could rise to ~23K/annum from 9.5K-10K in FY16-17.

3Q18 earnings gap-up. Given a combination of the above factors: (1) 19%qoq increase in Mazda TIV (2) Associates’ return to profits (3) Absence of CX5 run-out – estimated to have impacted 2QFY18 by RM5m-RM6m; 25% of 2Q18 profit (4) Price hike for new CX5 from Jan18 (5) A weaker JPY; we estimate 3Q18 earnings to rise by >50%qoq, underpinning our view of an earnings gap-up from 2HFY18.

The next CKD volume catalyst. BAuto is expected to launch the new CX8 in 2QCY18 for the Malaysian market, initially to be sold in CBU form before local assembly in CY19F and eventually exported to the region. The CX8 will fill in a vacuum in the RM180K-RM280K SUV segment (CX8 likely be priced at sub-RM200K price points), positioned to compete mainly against Toyota’s Fortuner. The CX8 is a 7-seater SUV which comes off the CX9 platform. Launched in Japan in Dec17 at a price tag of JPY3.2m-4.2m (RM120K-RM160K), Mazda was initially targeting monthly sales of 1.2K units, but ended up with a massive 12K bookings

Volume growth and margin recovery for Malaysia. BAuto is targeting FY18F Malaysia sales volume of 11.5K – 12K before rising by 17%-30% to 14.5K-15K in FY19F, mainly driven by full year contribution of the new CX5 and in part, contribution by the CBU CX8 from 2HCY18. Once the CX8 is locally assembled, BAuto is targeting volumes of 1K- 2K a year for the domestic market but a much larger 3K-4K for exports, mainly to the Philippines initially. We understand the CX8 is qualified for EEV (Energy Efficient Vehicle) incentives once localised and will be MMSB’s 2nd export model after the CX5. Additionally, EBIT margins for domestic operations are likely to recover to >10% levels against the depressed levels of 7%-9% in the past few quarters as run-out of the old CX5 has reached an end, inventory levels normalise and exposure to more favourable spot Ringgit levels increase. Other than the CX8, BAuto is also scheduled to launch the new Mazda 6 (CBU) in 3QCY18.

IPO plans delayed. For the Philippines operations, earnings has been negatively impacted by the weak Peso (the majority of imports are from Japan), despite strong volume growth (+16%yoy in 1HFY18). Meanwhile, pricing of models in the market has been raised by 4%-5% (by all players) from Jan18 as a result of the duty hike by the Philippines Government. Management is not too worried on the impact on demand as the hike in vehicle duties comes with income tax reduction for consumers. The IPO of 60%-owned BAuto Philippines has been pushed back, possibly to CY19F till after the new CX8 is launched in order to maximize values. We understand however that the previous IPO plan (valuing BAP at 15x PER) was up to 3 times covered suggesting scarcity-driven demand given the lack of automotive consumer stocks in the Philippines market.

Earnings revision. Though our thesis on BAuto’s earnings improvement moving into FY19F remain intact, our FY18F earnings is trimmed to RM129m from RM170m to reflect more conservative expectations, specifically: (1) Higher JPY for FY18F – this is because BAuto had already locked in its JPY exposure up till Apr i.e. till end FY18 at RM3.85:JPY vs. spot rates of RM3.5-3.6. However, we gather that BAuto had locked in much more attractive rates of RM3.5-3.6 beyond Apr18 given 3-4 months forward hedging (2) Lower FY19F TIV for Philippines given 4%-5% price hike as a result of higher duties. (3) Weaker Peso (against JPY) hitting BAP earnings. Nonetheless, we expect group earnings to grow by a CAGR of 35% over FY18F - FY20F driven by: (1) FY19F Malaysia TIV growth of 11% from full year impact of the new CX5 – our FY19F Mazda TIV projection of 13.2K is conservative relative to management’s 14.5K-15K (2) Margin expansion given the new CX5 price hike, absence of old CX5 run-out and weaker JPY (3) Launch of the new CX8 in 2QCY18. Our JPY assumptions for BAuto stands at RM3.9:JPY for FY18F and RM3.7:JPY for FY19F-20F.

Recommendation. Re-affirm BUY on BAuto and raise our TP to RM2.70 (from RM2.50) previously after rolling over our valuations to CY19F from CY18F. From a valuation standpoint, BAuto is cheap at just 11x CY19F earnings, relative to historical sector PE of ~12x, while dividend yield of 7% is attractive. BAuto is an entrepreneur driven, highly cash generative asset-light business while the capex-intensive manufacturing unit is parked under 30%-owned MMSB and is kept off-balance sheet. MMSB itself is already self-funding. Manufacturing capex has peaked having built up production capacity to 34K units/annum (on 2-shift) – FY19F-20F is mostly about monetising this incremental capacity via new models i.e. CX5 and CX8 and export expansion to South East Asia ex-Vietnam. Key share price catalysts in the next 12 months:

(1) An 11%yoy Mazda TIV growth (FY19F) coupled with margin expansion driven by full year impact of new CX5 from 3QFY18 onwards

(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) Launch of CBU CX8 in 2QCY18 and CKD variants in CY19F.

(5) Attractive dividend yield of 7% - net cash accounts for 10% of market cap coupled with solid 9% FCFE yield (FY19F). Our payout assumption is capped at 80% vs. historical 80%-113% payout.

Source: MIDF Research - 20 Feb 2018