Accelerating real GDP growth in 2014, positive demographics and low unemployment rates are supportive of resilient consumption spending. However, households are already stretched while the rising cost of living could dampen consumer discretionary spending on big ticket items like cars. TIV could reach 675,000 units in 2014 but cut-throat competition will crimp margins. Prefer DRB-HICOM and Tan Chong.

• Economic growth gathering pace.RHB economists forecast real GDP growth to accelerate to 5.4% in 2014 (2013F: +4.7%), underpinned by sustained domestic demand and an improving external environment. Financing remains available for qualified buyers. The pipeline of new models remains strong while the competitive marketplace will yield ongoing promotions and deals to entice car buyers. The introduction of more value-for-money (VFM) models by car manufacturers will also help to sustain sales volume. We expect TIV to reach 675,000 units in 2014
• Growth constraints.We acknowledge that households are already stretched with household debt/GDP at 85.1%. Cost of living is also spiralling, with higher electricity tariffs and fuel costs arising from the Government’s subsidy rationalisation programme. Inflationary pressure is on the rise with higher interest rates on the horizon. These factors will be negative for consumer discretionary spending. The planned introduction of goods and services tax (GST) in Apr 2015 could also lead to unpredictable consumer behaviour.
• Key market trends.We expect competition in the marketplace to remain intense and consumers to become increasingly price-sensitive, with more buyers trading down to cheaper models. Auto manufacturers are likely to respond to these trends by introducing more VFM models. All these trends point to increasing margin erosion. We expect the current duty exemptions for hybrid vehicles – which will expire at end-2013 – to be restricted to locally-assembled hybrid vehicles only.
• New NAP.After a lengthy delay, the third iteration of the National Automotive Policy (NAP) will be announced in Jan 2014, which will set the direction of the automotive industry for the next decade. We do not expect the NAP to be a re-rating catalyst for the sector in the near term, as benefits from a well-conceived policy will likely take several years for production plans to come to fruition.
• NEUTRAL.Sector valuations adequately reflect industry prospects and see few catalysts that will re-rate the sector higher. DRB-HICOM (DRB MK, BUY, FV: MYR3.40) is attractive for its latent earnings potential and hidden asset value. There is some early evidence of a nascent turnaround at Proton with its new global small car (GSC) due for launch in 2014. We like Tan Chong (TCM MK, BUY, FV: MYR7.25)’s long-term regional growth strategy.

• 2013 auto TIV to exceed 650,000 units
• 2014 auto TIV forecast: 675,000 units
• Auto sales to be underpinned by resilient domestic consumption spending
• Malaysian households are increasingly stretched
• Key trends include cut-throat competition,rising consumer choices, consumers becoming increasingly price-sensitive, as well as margin pressure for distributors
• New NAP is unlikely to be a re-rating catalyst
• Regulatory changes and unpredictable consumer behaviour are key risks
• Tan Chong and DRB-HICOM the Top Picks

Volume growth in 2014 albeit slower 
2013 has been a stop-start year for the auto industry volume-wise. Auto sales began the year well, with 1Q13 growth surging 13.8% y-o-y, helped by a low base in 2012 when the industry was hit by supply chain issues in addition to new responsible lending guidelines. Total industry volumes (TIV) in 2Q13 slowed, declining 1.3% q-oq and bringing cumulative 1H13 growth to 4.1% y-o-y. This was due to consumer hesitation in the run-up to the GE13 in May from market talk and sensationalist media reporting on the possibility of lower new car prices. Auto sales then rebounded in 3Q13 (+12.0% q-o-q, YTD +6.4% y-o-y) as consumer expectations moderated, helped by the boost in sales from the Aidil Fitrifestive holidays and the strong market reaction to the value-for-money (VFM) Proton Saga SV. We expect 2013 TIV to exceed 650,000 units. We think auto sales will continue growing albeit at a slower pace and forecast TIV of 675,000 units in 2014.

Green light: key growth drivers 
RHB economists expect the economy to pick up pace with real GDP expanding 5.4% in 2014 (2013: +4.7%), underpinned by a sustained increase in domestic demand (a revival in the private investment cycle, a sustained increase in consumer spending, young demographics and favourable labour market conditions). A brightening external environment will also help to lift growth and consumer sentiment. Liquidity remains ample and financing is available for qualified buyers. Resilient consumption spending will underpin demand for passenger cars while a pickup in economic activity will lift commercial vehicle sales. The pipeline of new models remains strong going into 2014, while the competitive marketplace will yield ongoing promotions and deals to entice car buyers. The introduction of more VFM models by car manufacturers will also help to sustain sales volume.

Amber light: proceed with caution! 
We acknowledge that households are already stretched with household debt/GDP at 85.1%. Cost of living is also spiralling, with electricity tariffs rising and fuel costs trending up from the Government’s subsidy rationalisation programme. Consequently, inflationary pressure is on the rise with higher interest rates on the horizon. These factors will be negative for consumer discretionary spending.

Key trends in 2014 
Competition in the marketplace will remain intense. With new marques entering the market and trying to grow market share, consumers are increasingly spoilt for choice. While the Government has committed to lowering car prices by 30% in five years (without any change in the duty structure) by promoting competition and streamlining the industry, we think the initial progress will be slow-going as there are no incentives for the auto distributors to give up their profits given limited volume growth prospects. We expect consumers to become increasingly price-sensitive and expect more buyers to trade down to cheaper models. Auto manufacturers are likely to respond to these trends by introducing more VFM models. All these trends point to increasing margin erosion. We expect the current duty exemptions for hybrid vehicles – which will expire at end-2013 – to be restricted to locally-assembled hybrid vehicles only.

Toyota is the biggest loser here given that the Prius, Prius Cand Lexus CT200h hybrids all do not enjoy sufficient economies of scale to be considered for local assembly. The Camry Hybridhas been reported to be in the planning stage for CKD by 2H14 but will not be a volume seller. The only hybrid vehicle being assembled locally is the Honda Jazz Hybrid. The planned introduction of GST in April 2015 could also result in unpredictable consumer behaviour towards the end of 2014. The base case expectation is for a slight downward reduction in car prices as the 6% GST replaces the 10% sales tax. However, as GST is a tax on the value added at each stage of the supply chain, it is difficult to predict the final impact on selling prices when the GST regime comes into force.

New National Automotive Policy 
The third iteration of the National Automotive Policy (NAP) is finally expected to be announced in Jan 2014 after a lengthy delay. The policy document is expected to be comprehensive, cutting across the entire automotive eco-system, addressing issues such as training and education, autoparts supply chain, fuel standards, vehicle endof-life, green technology roadmap and vehicle safety standards. The NAP is expected to set the direction of the automotive industry for the next decade. The automotive duty structure is expected to remain unchanged for the time being. The objective of the NAP is to transform Malaysia into a regional production hub for energy-efficient vehicles (EEV). Nonetheless, the reality isthat Thailand and Indonesia are already established regional production hubs, with industry policies promoting eco car and low-cost green car programmes respectively. We do not expect the NAP to be a rerating catalyst for the sector in the near term, as benefits from a well-conceived policy will likely take several years for production plans to come to fruition. In the medium to longer term, automotive parts suppliers that can innovate and raise efficiency levels to regional standards stand to benefit from the increased manufacturing presence of global original equipment manufacturers (OEMs) in Malaysia. The much touted vehicle end-of-life policy is actually a misnomer and is not a vehicle scrapping policy. It is believed that the NAP will put in place a road map to implement a mandatory vehicle inspection policy for vehicles over a certain age. Vehicles that fail the test will have the opportunity to undergo repairs before it can be certified roadworthy. Before this policy can be implemented, a vehicle inspection infrastructure needs to be put in place. Puspakom currently operates a network of inspection centres to conduct mandatory inspection of commercial vehicles. In addition to Puspakom, a unit of DRB-HICOM also carries out inspections for private vehicles prior to financing and auction, as well as valuation and voluntary inspections. However, it does not have the capacity to be able to also inspect private vehicles numbering in the millions. This could mean new opportunities for Puspakom but could also allow new competitors into the vehicle inspection business.

Key risks 
These include unexpected regulatory changes, unfavourable forex trends, availability of financing, unpredictable consumer behaviour and a weakening of consumer confidence.

NEUTRAL 
No changes to our NEUTRAL call on the sector. Sector valuations adequately reflect industry prospects and we see few catalysts to re-rate the sector higher. We like Tan Chong (TCM MK, BUY, FV: MYR7.25) and DRB-HICOM (DRB MK, BUY, FV: MYR3.40). We like Tan Chong’s long-term regional growth strategy, with plans to make inroads into markets in Indo-China and Myanmar. Domestically, the Nissan franchise is expected to continue growing its market share helped by a more active product cycle strategy, while higher contract assembly volume will also bring scale benefits and lower unit costs. We like DRB for its latent earnings potential and hidden asset value. Continued evidence of a sustainable turnaround at Proton, a more substantive collaboration arrangement with Honda and the commencement of armoured vehicle contract deliveries could help to re-rate the stock higher.

Source: RHB