• 1Q19 earnings in-line with ours but below consensus

• Improved model mix but weak Ringgit may dampen earnings recovery, Vietnam dipped into losses

• Revised down FY19F/20F by 9%/8% to factor in revised forex assumptions following OPR cut

• Downgrade to NEUTRAL from BUY at revised TP of RM1.65

1Q19 earnings in-line. Tan Chong registered core earnings of RM22m for its 1Q19. This is broadly in-line with our expectation but short of consensus accounting for 22% and 20% of full year estimates respectively. Core earnings were up 56%yoy but contracted 68%qoq against an exceptionally strong 4Q18.

Improved model mix. Nissan TIV was down marginally by 3%yoy. Despite the year-on-year fall in volumes, automotive segment revenue was up 5%yoy driven by an improved model mix. On sequential basis, revenue was down 8%qoq on the back of a 34% fall in Nissan TIV.

Forex and cost factor. Margins contracted quarter-on-quarter - we estimate forex was booked in at around USD:RM4.17 in 1Q19 (assuming a quarter lag), weaker compared to 4Q18 estimate of USD:RM4.09, while Vietnam operations returned to losses in 1Q19, albeit marginal, after turning profitable in 4Q18. On a year-on-year basis, forex is estimated to have registered at almost similar levels but operating margins improved given improved model mix following launch of the new Urvan in Mar18 and new Serena Hybrid in May18. On top of this, costing for the new models are negotiated based on updated forex rates. FY19F will see the full year impact of these 2 new models plus at least one new model launch this year. Unlike in the past, new model launches are unlikely to be volume-driven as Tan Chong shifts focus on more profitable and less crowded segments.

Weaker RM going forward. A potentially weaker RM following the recent OPR cut could somewhat drag a further recovery in Tan Chong’s earnings. 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.

Earnings revision. Our economics team revised down our FY19F USD:RM forecast from USD:RM4.05 to USD:RM4.12 (full year average) recently following Bank Negara’s decision on the benchmark rates. In accordance, we revise our forward assumptions, resulting in a 9%/8% downward revision to our FY19F/20F earnings. We now expect Tan Chong to register earnings contraction of 25% in FY19F (vs. an expected 18% contraction previously), before recovering by 15% in FY20F.

Termination of Nissan Vietnam Ltd’s (74%-owned) loss making operations will eliminate some losses (estimated RM11m net loss in FY17), but the termination will only take effect in Sep19. Volumes for Vietnam operation is equally split between CKD and CBU. Tan Chong will still retain the CKD operations, which is also, still loss making currently.

Downgrade to NEUTRAL. Following the downward earnings revision, we downgrade Tan Chong to NEUTRAL from BUY previously and trim our TP to RM1.65/share (from RM1.80/share) still pegging Tan Chong to 12x FY19F earnings. Having said that, we note that Tan Chong is still trading at depressed PBV of 0.4x; while we see limited upside catalyst at present, downside risk is also buffered by depressed valuation of its assets.

Source: MIDF Research - 15 May 2019