• FY18 outperforms expectations by a mile

• Earnings strengthened further in 4Q18 after 2-years of losses; underpins our earnings turnaround thesis

• Volumes normalised but margins strengthened further

• Re-affirm BUY but TP lowered to RM1.80 given switch to earnings-based valuation

FY18 beats expectations. Tan Chong reported core net profit of RM70m for its 4Q18, bringing FY18F core net profit to RM125m – well ahead of both our and consensus expectations. A final dividend of 2sen was declared, bringing FY18 dividends to 4sen/share, against our earlier estimate of 3sen/share.

Margin improvement. Despite Nissan TIV falling 11%qoq given normalisation of exceptionally strong tax holiday-driven sales in 3Q18, margins continued to improve. This was attributed to a favourable sales mix (possibly due to higher proportion sales of the Serena Hybrid) while management indicated in its last briefing that it increased hedging levels right at the peak of the RM vs the usual 3-months forward hedging.

Better underlying margins than expected? We may have earlier underestimated the margin improvement from the Serena Hybrid – Tan Chong’s earnings started improving dramatically from 3Q18 onwards, post-launch of the Serena Hybrid (in mid-May18) and Urvan (Mar18). FY19F will see the full year impact of the Serena Hybrid.

New launches negotiated around latest rates. Kit pricing of new launches (Serena Hybrid and Urvan) is negotiated based on current forex levels (vs. Almera which was negotiated when the USD was at RM3.20:USD levels back in FY12). This is a key factor swinging Tan Chong back to profitability in FY18.

To focus more on profitability. The margin improvement is in line with management’s indication to abandon its past volume driven strategy e.g. Almera B-segment and shifting focus on profitable and less crowded segments.

Vietnam ops also drove improvements. Vietnam broke even for the first time (EBITDA level) in 3Q18 at RM3m and this expanded further to RM9m in 4Q18 following compliance with Decree 166 regulation requirements which saw volumes increasing by 279%qoq back in 3Q18 – sales driven mainly by the Navara.

Re-affirm BUY. Our FY19F is raised 43% to reflect better than expected margins from the new launches and we introduce our FY20F – we expect FY19F to contract given our USD:MYR assumption at RM4.05 (vs. RM3.90 in FY18). Re-affirm BUY but we now switch to an earnings based valuation – pegging Tan Chong at 12x FY19F earnings to derive a new (but lower) TP of RM1.80 (from RM2.10). Key catalysts: (1) New model launches negotiated around latest forex rates (2) Ringgit strength (3) Narrowing losses from Indochina operations.

Source: MIDF Research - 26 Feb 2019