• 1H19 missed expectations; underpins our recent downgrade

• Strong Perodua performance but dragged by weak Toyota TIV and Perpetual Sukuk interest

• FY19F/20F earnings revised down to reflect lower volume expectations, impact from weaker RM from 3Q/4Q19

• Maintain NEUTRAL at a lower TP of RM5.35/share

1H19 missed expectations. UMW’s 2Q19 net profit came in at RM84m for 2Q19, bringing 1H19 core earnings to RM171m. This accounted for just 41% of our FY19F and 39% of consensus. The weaker than expected results underpins our recent downgrade of UMW, premised on a weaker Ringgit, incremental interest from the Perpetual Sukuk (PERP) and incremental cost from the new Bukit Raja plant.

Automotive segment. Underlying automotive pretax earnings improved 6%yoy and some 22%qoq given significant improvement in Toyota TIV sequentially (28%qoq). Additionally, associate contribution improved 16%qoq and some 40%yoy driven mainly by Perodua. Despite the earnings improvement at the auto division, overall group earnings were pretty much flat sequentially, dragged by the PERP profit payment of RM35m in 2Q19. Furthermore, Toyota TIV has so far underperformed our FY19F of 75K units. Compared to 1H18, Toyota TIV actually contracted by 1.4%.

Weak Ringgit. The impact of the weaker Ringgit post-OPR cut in May19 is likely to start dragging automotive division margins from 3Q19/4Q19 onwards – auto players typically buy forward ~3-months inventories. UMW is one of the more sensitive auto stocks (under our coverage) to forex volatility – every 1% change in the Ringgit impacts our FY19F by 3.5%.

M&E division turnaround. Positively, the M&E division is now delivering consistent profits. 2Q19 M&E revenue was up 37%yoy while earnings improved to a pretax profit of RM13m from a pretax loss of RM0.5m in 2Q18, driven by the ramp-up of fan case production at the aerospace division. The aerospace division is expected to start to deliver more meaningful annual earnings from FY20F onwards.

Forecast revision. Given the weaker than expected results, we trim our FY19F/20F by 12%/16%. This is mainly to reflect: lower Toyota TIV – we now expect an 8.5%yoy FY19F growth from +14%yoy previously as volumes so far had underperformed. Our FY19F/20F USD:RM assumption remains unchanged at USD:RM4.12 (revised down in our previous stock downgrade report).

Recommendation. We remain NEUTRAL on UMW at a lower TP of RM5.35 (from RM5.85 previously) following the earnings downgrade in this report. While we stick to our view that Bukit Raja is a significant game changer for UMW, we would expect some gestation period before more meaningful earnings accretion kicks in. We recommend switching into MBM for a much cheaper exposure to Perodua’s record TIV and for solid dividend yields.

Source: MIDF Research - 28 Aug 2019