KEY INVESTMENT HIGHLIGHTS

• Returns to core net profit in 3Q20, results within expectations

• Sequential improvement, but year-on-year possibly impacted by run-out of old Almera and Vietnam losses

• New Almera is an important catalyst for earnings turnaround, positioned at higher price points and costing negotiated closer to current forex levels

• Maintain NEUTRAL at unchanged TP of RM1.00

Returns to core profits. Tan Chong turned to the black in 3Q20, registering a core net profit of RM7m for its 3Q20 (normalised for gain on disposal of RM2m and forex loss of RM16m). This narrowed the 9M20 core net loss to RM97m (from RM103m in 1H20). The 3Q20 results were within expectations as we expect Tan Chong’s 4Q20 to turn in more meaningful profits following launch of the new Almera.

Key takeaways. The 3Q20 core net earnings of RM7m was a significant improvement compared to the RM79m core net loss in 2Q20; the latter was impacted by the MCO from mid-March to early-May. 3Q20 Nissan TIV was up 193%qoq to 4785 units driven by the PENJANA sales tax holiday, though it is still down ~10%yoy given limited new launches in 1H20 and a competitive environment. Despite indirect A&P support in the form of a sales tax discount, auto division margins were lower yearon-year (EBITDA margin down 50bps to 5.9%), which we think is due to run-out of the previous generation Almera ahead of launch of the replacement model in 4Q20.

Balance sheet position improved. Reflecting the inventory rundown, inventory levels dropped significantly to RM860m (-31%qoq). 3Q20 operating cash flows improved to RM522m (2Q20: -RM63m), which was mainly due to the inventory reduction, while net gearing improved further to 39% (2Q20: 46%). Given launch of the new Almera in November however, we would expect some increase in 4Q20 inventory levels.

New model kicker. The new N18 Almera (B-segment sedan), which is Tan Chong’s bread-and-butter model, was officially launched on 1st November. The previous generation Almera was launched in 2012 – negotiations and kit pricing would have taken place during the 2011- 2012 period, when the Ringgit was at around USD:RM3.20 levels. Given significant depreciation of the Ringgit now (which is at USD:RM4.10-4.20 levels), the previous generation Almera would have turned into a barely profitable model, which was one of the key drags to group earnings.

Positively, costing for the new Almera is likely to have been negotiated closer to current forex levels. Reflecting this, the new Almera is now priced at higher price points of RM80K-91K, circa 11%-16% higher than the previous generation Almera’s pricing, which should improve margins generated from the model significantly and is a key catalyst to drive more meaningful earnings turnaround from 4Q20.

Drag from Vietnam operations. LBITDA from the Vietnam operations widened to RM25m in 3Q20 (3Q19: RM9m LBITDA) as the group’s Danang plant remains underutilized, which will be further dragged by termination of the group’s Nissan franchise in Vietnam in September 2020. The group had however made progress after being appointed as the MG brand’s exclusive CBU importer and distributor in Vietnam since May; 2 new CBU SUV models were launched in August, though this has yet to bear significant results at this juncture.

Recommendation. Maintain NEUTRAL on Tan Chong at unchanged TP of RM1.00; our valuation continues to peg Tan Chong at 10x FY21F earnings. The new Almera is likely to be an important catalyst to drive an earnings turnaround for the group, but we remain cautious of the drag from Tan Chong’s Vietnam operations in the near-to-midterm. We await further updates from Tan Chong’s upcoming results briefing.

Source: MIDF Research - 25 Nov 2020