Our NEUTRAL stance on the sector is unchanged. While underlying consumer demand is strong, the market is being rocked by consumer hesitation that has not been helped by sensationalistic media reporting that has confused potential buyers. While we expect sales to normalise, we think the sector is unlikely to significantly re-rate until the regulatory environment is clearer.

- Regulatory risk expectations are playing out.  The concerns that we had expressed on the preceding quarter’s strategy, of a likely sales blip caused by election-related promises to lower car prices, are materialising. Vehicle sales in the past two months have been affected by heavy sensationalistic media coverage on the cheaper car price phenomenon. Clearly, many consumers have chosen to adopt a wait-and-see stance, given the lack of clarity on precisely how the price reductions will be implemented. Total industry volume (TIV) for May reached just 49,634 units, slumping 14.9% y-o-y and 5.4% m-o-m, according to data from the Malaysian Automotive Association (MAA).

- Gradual price reduction will  maintain market stability. The plan to gradually bring down prices is aimed at maintaining stability in the market. The recent “price reductions” have tended not to involve an outright reduction in vehicle list price. This will limit the downward pressure on used vehicle residuals.  Our base case expectation is for sales to gradually normalise and move higher in 2H13, as consumers gradually understand the Government’s strategy on vehicle prices and expectations for significant reductions in car prices moderate.

- Increased competition will pressure margins. The Government’s current automotive pricing strategy revolves around raising the level of competition in the market place and eliminating industry inefficiencies in order to gradually drive prices lower without any explicit reduction in automotive duties. To this end, weaker JPY exchange rates, and squeezing auto parts and component suppliers have helped. Further reduction in the cost structure may have to be extracted from higher local content targets, which could yield lower effective excise duty rates.  Nonetheless, the heightened market competition will continue to pressure industry margins

- Still NEUTRAL. While sector valuations are undemanding, there are few explicit catalysts to re-rate the sector higher. The lack of clarity on regulatory issues remains the main drag. Our top picks in the sector are Tan Chong (BUY, FV: MYR7.30) and DRB-HICOM (BUY, FV: MYR3.30).

Source: RHB