The auto sector’s June quarter results disappointed, as a 4.3% y-o-y TIV contraction offset a weaker JPY. Prospects for 2H13 auto sales remain positive, with moderating consumer expectations of lower car prices helped by some pent-up demand, fierce market competition and a strong new model pipeline. Headwinds from a weak MYR and a more uncertain economic outlook will cap sector performance. NEUTRAL.

- Disappointing results. The June quarter results of the auto stocks under our coverage were disappointing. Four companies reported earnings that were below expectations, while one (APM Automotive) surprised on the upside after securing new supply contracts that helped lift earnings. We believe auto companies generally booked in favourable MYR/JPY exchange rates during the quarter, which helped to offset tepid industry sales volume.

- Better sales expected in 2H13. During the June quarter, total industry volume (TIV) contracted 4.3% y-o-y and 1.3% q-o-q as consumers withheld their purchases ahead of the May general elections, pending further clarity on market talk of lower car prices. However, we maintain our base case expectations of better industry sales in 2H13, potentially bolstered by pent-up demand, aggressive marketing promotional campaigns and the launch of volume selling models including the Proton Saga SV, Toyota Vios, Nissan Grand Livina MPV and Honda Accord.

- Headwinds could cap sector performance. The weak MYR poses a risk to margins in the coming quarters, with the JPY having gained 11.9% since May while the USD is up 7.6% YTD. Regulatory risk is also a concern with the long-delayed National Automotive Policy due to be announced later this year. The rising cost of living from a rollback of subsidies, coupled with potentially higher inflation and interest rates next year, could also crimp consumer discretionary spending going forward, especially given the already high household debt levels.

- Outlook. While the prospects for the remainder of the year appear stable, earnings visibility in 2014 is less well-defined. A less accommodative financing environment is a key risk. We retain BUY calls on DRB-HICOM given its significant turnaround potential and deep value asset backing, as well as Tan Chong for its strong new model pipeline and regional ambitions. Overall, we think the sector valuations are fair and see few catalysts to re-rate the sector higher. NEUTRAL.

Source: RHB