KEY INVESTMENT HIGHLIGHTS

• Earnings recovery in 2QFY21, but yet to get to full potential given drag from 6+6 program; 2QFY21 underperformed

• Gradual weaning off of aggressive promotional activities by Jan 2021 to drive next leg of margin recovery

• Key catalyst (i.e. brand expansion drive) remain intact; balance sheet improved significantly in 2QFY21 – positions group well for new brand acquisitions

• Maintain BUY albeit at a lower TP of RM1.70 given earnings revisions

Strong earnings recovery, but yet to get to full potential. BAuto reported a core net profit of RM26m for its 2QFY21, which brought 1HFY21 core earnings to RM36m. Though the 2QFY21 earnings recovered strongly (+155%qoq, +19%yoy), it was short of our and consensus expectation as margins have yet to fully recover given the ongoing 6+6 year free maintenance/warranty program, while associate contribution was still depressed, albeit improving. An interim dividend of 1.25sen/share was announced (1HFY21: 1.75sen/share), representing a generous 57% payout against core earnings.

Key takeaways. 2QFY21 core earnings was up 155% sequentially and 19%yoy to RM26m. Growth was driven primarily by a recovery in Mazda TIV (+32%qoq / +47%yoy) and margin recovery (EBIT margin: +1.5ppts sequentially to 5.7%). The sequential margin recovery was mainly due to: (1) Absence of insurance subsidy promotion, (2) Absence of 2019 CX5 stock clearance, which were offered in 1QFY21. Associate contribution returned to the black in 2QFY21 given recovery in production volume. 60%-owned BAP remained in losses (at PAT level), but this has narrowed substantially by 61%qoq to just RM0.6m.

Margins recovered, but not as strong yet. EBIT margins were up 1.5ppts sequentially to 5.7%, but this still reflects a drag from the 6+6 year free warranty & maintenance promotion. Though the additional 1 year (against 5 year originally) has to be fully provided for in the P&L, impact on cash flows are not as significant since the cars that are sold, only return for servicing on a gradual basis. More importantly, we understand that the promotion will be discontinued from Jan 2021 - this should provide the next leg of catalyst for a margin recovery.

Associates on the path to recovery. Given the drive to run-down inventory, MMSB has been lagging in its production recovery. Still, MMSB’s loss after tax narrowed to RM2.4m in 2QFY21 (from an LAT of RM20m in 1QFY21 driven by higher production volumes (+884%qoq to 2449 units). This should improve going forward as export volumes pick up pace from October onwards, and given sustainable volumes domestically. We expect MMSB to return to the black from 3QFY21 onwards.

Cash position improves further; war chest being readied. Balance sheet position improved significantly in 2QFY21. Net cash improved to RM227m from RM71m in 1QFY21; inventories/receivables were pared down by 20%/16%qoq, while borrowings (short-term only) were pared down 57%qoq to just RM129m. Additionally, we highlight again that the 6-year free maintenance (an addition of one year to the original terms) drags P&L, but does not impact cash flows significantly, as the cars return for servicing on a gradual basis. This strong war chest positions BAuto for structural growth driven by brand expansion.

Earnings revision. Given the weaker than expected results, we conservatively revise lower our FY21F/22F by 28%/24% to reflect mainly lower margins expectations. Despite the revision, we nonetheless still expect earnings to recover by 66% in FY22F driven by sustainable volumes and a further recovery in margins in the absence of further aggressive promotional activities. This should be coupled with normalizing volumes at the manufacturing associates (Inokom and MMSB). Our forecasts are now conservatively 26%/5% below consensus over FY21F/22F.

Key catalyst remain intact. The key catalyst for BAuto is its brand expansion drive. The recent Peugeot distributorship win (via 20%-owned Berjaya Auto Alliance Sdn Bhd - BAASB) is a positive but just a small part of the expansion drive. The big one, we believe is a potential win of the Kia distributorship, where BAuto is likely to take a majority stake and play a role in the CKD operations (for more details refer to report dated 2 nd December 2020). We also would not rule out a potential role as a regional hub should talks materialize favourably. Meanwhile for BAASB, we think there is a chance that it could turn in some small profits even in the first year of operations, provided the legacy 5+5 year warranty program left by Naza, remain manageable. BAASB’s immediate-term focus is on addressing after-sales; expensive and shortage of parts, via alternative OEM sourcing.

Recommendation. Maintain BUY on BAuto. Our TP is trimmed to RM1.70 (from RM1.75) – despite the earnings revision, we now shift to a higher 16x CY21F PER, at 1SD above historical mean, as the sector transitions into a recovery cycle. This will be coupled with a potential brand acquisition leading to a structural expansion in market share, which should drive a strong valuation re-rating for BAuto. Key catalysts: (1) Demand recovery driven by underlying macro improvement (2) Margin recovery as aggressive promotional activities are gradually weaned off (3) Potential introduction of a 3rd CKD model (4) Potential brand expansion riding on BAuto’s solid balance sheet and Inokom’s capacity expansion (5) Potential NAP incentives to drive CBU exports. Risk to our call is a second wave of the pandemic and weaker than expected demand recovery.

Source: MIDF Research - 11 Dec 2020