Post the successful IPO of UMWOG, UMW Holdings is in  an unenviable position  where  it  lacks  core  businesses  that  could  be  strong  growth drivers.  Toyota  is  already  the  non-national  market  leader  in  a  mature domestic  automotive  market  with  limited  near-term  growth  prospects. Management  has  also  failed  to  effectively  communicate  a  credible strategy for its non-core O&G assets. Maintain NEUTRAL, FV MYR11.30.

• Automotive division still the backbone.  Toyota sales for 1Q14 got off to a good start  with new  vehicle registrations for the quarter of 24,634 units 21% up y-o-y,  helped by the introduction of the all new  Vios  in Oct 2013  in  addition  to  the  new  Corolla  Altis  in  Jan  2014.  Toyota  sales  to date  are  on  track  to  meet  our  2014  volume  forecast  of  100,000  units (+8.1% y-o-y). Our channel checks suggest that the  Vios  is selling well with vehicle deliveries running at >3,000 units per month. This will help to offset  the  end  of  Prius  and  Prius-C  hybrid  models  in  Malaysia. Nonetheless, competition in the market continues to be stiff. We expect Toyota sales to be largely unaffected by the recent hike in auto financing rates  given  the  demographic  of  the  typical  Toyota  (and  Lexus)  buyers who are mainly from the middle to upper income segments.
• UMW  Oil  &  Gas  (O&G)  growing steadily.  55%-owned UMW Oil & Gas (UMWOG MK, NR) continues to add rig capacity to tap  into  the  present bullish industry conditions. It currently owns four rigs that will rise to eight by  2015.  Industry  conditions  for  local  players  remain  bullish  with  a continued focus on marginal oil fields and a dearth of locally-owned rigs. UMWOG  is  currently  bidding  for  20  contracts  with  markets  in  Vietnam and Myanmar expected to grow strongly.
• Group  strategy  for  non-core  O&G  business  remains  fuzzy.  UMW’s non-core O&G business (dubbed the Value Group) comprises a motley collection of businesses that were not included in the listing of UMWOG.
• Forecasts and investment risks.  We leave our forecasts unchanged. The  main  risks  to  our  call  include:  i)  regulatory  changes,  ii)  tighter financing  environment,  and  iii)  weaker  economy  and  more  cautious consumer spending patterns affecting car sales.
• Investment  case.  We  trim  the  FV  for  the  stock  to  MYR11.30  (from MYR11.50)  after updating our valuation parameters.  We see few near term rerating catalysts until there is better clarity on  its  strategic growth direction.  UMW’s  share  price  could  be  supported  by  the  reasonable 4.6% yield derived from assuming a 67% payout policy (2013: 75.5%).

Looking For New Growth Drivers

Automotive division still the backbone of the group.  Toyota sales for 1Q14 got off to a good start.  New Toyota vehicle registrations for the quarter of 24,634 units was  21%  up  y-o-y,  helped  by  the  introduction  of  the  all  new  Vios  in  Oct  2013,  in addition  to  the  new  Corolla  Altis  in  Jan  2014.  Sequentially,  however,  1Q14  sales were down  10.7% q-o-q due to  the recent Lunar New Year holidays and aggressive marketing campaigns seen towards  end-2014. Toyota sales to date are on track to meet our 2014 volume forecast of 100,000 units (+8.1% y-o-y).  Our channel checks suggest that the Vios is selling well with vehicle deliveries running at over 3,000 units per  month.  This  will  help  to  offset  the  end  of  Prius  and  Prius-C  hybrid  models  in Malaysia  due  to  the  cessation  of  the  duty  exemptions  at  end-2014.  Toyota  hybrid sales comprised 6% of sales volumes in 2013.  The  new National Automotive Policy (NAP) only provides for duty exemptions for locally assembled hybrid vehicles. UMW Toyota has plans to introduce a Camry Hybrid in the local market by end-2014. Other new models this year include a  new Hilux  pick-up truck.  Nonetheless, competition in the market continues to be stiff with manufacturers making a push for market share , in addition to other Japanese, Korean and continental marques.  News that the Honda City,  a  B-segment  direct  competitor  to  the  Vios,  has  secured  a  record  10,000 bookings within only a month of its launch in March will be worrying for UMW-Toyota,given that the Vios is expected to be a volume seller.

Lower-end segment feeling the pinch.  The higher cost of living and recent  hike in auto financing rate have a more pronounced impact on the lower-end segment of the automotive market, resulting in more cautious consumer spending patterns especially on big-ticket items. While marginal buyers will be priced out of the car market at the lower end, they will be replaced by buyers trading down .  Both Proton and Perodua have  both  seen  1Q14  sales  contract  4.7%  and  5.7%  respectively.  However,  we expect  Toyota  sales  to  be  largely  unaffected  given  the  demographic  of  the  typical Toyota  (and  Lexus)  buyers  who  are  mainly  from  the  middle  to  upper  income segments.

NAP implications for UMW-Toyota.  Since the unveiling of  the NAP in January, the Ministry  of  International  Trade  and  Industry  (MITI)  has  only  issued  one  energy efficient vehicle (EEV) manufacturing license to Go Automobile Manufacturing (GAM) to  assemble  Great  Wall  vehicles.  For  UMW-Toyota  to  cement  its  position  as  the Number  1  non-national  vehicle  manufacturer,  it  needs  to  be  in  a  position  to  take advantage  of  the  “customised  incentives”  for  the  manufacture  of  EEVs.  However, new investments in manufacturing facilities in Malaysia will need to be coordinated with Toyota Motor Corp’s manufacturing strategy for Asean as a new plant can only be justified if there is an export angle. While the current Assembly Services Sdn Bhd (ASSB)  plant in Shah Alam  is a relatively old facility with little room for meaningful expansion,  it  has  been  updated  over  the  years.  A  new  paint  shop  and  other improvements will lift annual plant capacity to 85,000 units (currently 70,000 units on two shifts) by mid-2014,  sufficient to cater for domestic demand. Currently, models assembled by ASSB include the Vios, Camry, Hilux, Innova, Fortuner and Hiace. The on-going  political  strife  in  Thailand  could  prove  to  be  a  silver  lining  for  Malaysia. Media reports have suggested that Toyota could reconsider its  new investments in Thailand if the political unrest drags on.

New Perodua plant nearly ready. We recently toured the Perodua plant in Rawang. It  was  evident  that  much  investment  had  been  put  in  to  upgrade  the  current  plant (200,000 units annual capacity). Management confirmed that the new plant   was on track to be commissioned by August  or September, which  will add a further 100,000 units capacity per annum.  The new plant will be EEV-certified and  it  is expected to manufacture  a  new  EEV-compliant  model  to  replace  the  Viva  that  will  cease production  by  mid-2014.  With  regional  exports  currently  running  at  below  10,000 units a year, this aspect will take on greater importance with the commissioning of the new plant. We understand that Perodua will also look at undertaking more contract manufacturing opportunities. The sales target for 2014 is 197,000 units (flat y-o-y).UMW Oil  &  Gas  growing steadily.  UMW  Oil &  Gas continues to add rig capacity to tap into the present bullish industry conditions. It currently owns four rigs that  will rise to eight by 2015, according to President Rohaizad Darus as quoted in a recent media interview. It was also revealed that  NAGA-5  could be delivered by end-April,  slightly earlier  than expected  (May)  and  will  be  immediately  deployed  on  a short-term sixweek  contract  with  NIDO  Petroleum  Philippines  with  a  contract  value  of  USD7m.

Three additional jack-up rigs are under order with one due for delivery by September and the second in December. Industry conditions for local players remain bullish with a continued focus on  marginal oil fields and a dearth of locally-owned rigs. UMWOG is currently bidding for 20 contracts with markets in Vietnam and Myanmar expected to grow strongly.

Group  strategy  for  non-core  O&G  business  remains  fuzzy.  UMW’s  non-core O&G  business  (dubbed  the  Value  Group)  comprises  a  motley  collection  of businesses that were not included  in the listing of UMWOG.  This division recorded a pre-tax loss of MYR317.4m in 2013  mainly as a result of goodwill impairment at its Indian investments.  These  businesses  are a legacy of its early foray into O&G that lacked focus and is a mix of controlling and non-controlling businesses.

• United Seamless Tubulaar (USTPL) is a key and challenging component of this division.  USTPL is a manufacturer of oil country tubular goods (OCTG) that began operations in 2010 and currently faces po wer supply issues and low utilisation rates. Production levels are still some way off break even and we believe that plans by the US to introduce countervailing duties of OCTG from India will not help matters. Management expects USTPL to take two to three years to turn around.
• WSP Holdings, a 22.5%-owned NYSE-listed manufacturer of seamless steel pipes  is  still  in  the  process  of  being  taken  private.  UMW  is  expected  to realise its remaining investment.
• Zhongyou BSS is a manufacturer of spiral submerged arc welded (SSAW) and longitudinal submerged arc welded (LSAW) pipes with China National Petroleum  Corp  as  a  major  customer.  This  company  is  one  of  the  few profitable bright spots within the division.
• Arabian  Drilling  Services  operates  four  onshore  drilling  rigs  in  Oman  that incurred operational losses in 2013 due to  the spike in labour costs arising from  the unrest in the Middle-East. Management sees better prospects for this company in 2014. UMW’s  management  reiterated  its  intention  to  turn  around  these  businesses  to unlock  their  value,  having  prioritised  significant  management  resources  to  achieve this  objective.  However,  management  was  unwilling  to  commit  to  a  timeline. Following the listing  of UMWOG and the classification of these O&G  businesses as “non-core”, we question the rationale for UMW to remain invested in these ventures for as long as it has.

Equipment  and  Manufacturing  &  Equipment  divisions  are  not  significant growth drivers. In 2013, the manufacturing and engineering (M&E) division recorded pre-tax losses of MYR35.9m due to losses in India relating to operating losses, asset impairment and forex losses from the depreciation of the INR vs USD. We expect the M&E division to remain a relatively small part of the group even if it manages to avoid incurring  non-recurring  losses.  The  equipment  business,  comprising  heavy equipment,  industrial  equipment  and  marine  &  power  equipment  businesses  is sizeable,  generating  a  pre-tax  profit  of  MYR191.1m  (+4.2%)  in  2013.  While  rising 
CPO prices could help to lift equipment demand, this could be offset by an impending ban  on  log  exports  from  Myanmar.  UMW  plans  to  focus  on  parts  sales  and equipment leasing.

Investment risks.  The main risks to our call include: i) regulatory changes, ii) tighter financing  environment,  and  iii)  weaker  economy  and  more  cautious  consumer spending patterns affecting car sales. We also note that UMW is currently the second smallest capitalised company of the 30 component stocks within the benchmark FBM KLCI.  The  stock  could  be  at  risk  of  dropping  out  of  the  index,  which  would significantly reduce the addressable investor base for the stock.

Forecasts.  Our  forecasts  are  unchanged.  The  tentative  date  for  the  1Q14  results announcement is 23 May.

Investment case. We trim the FV for the stock to MYR11.30 (from MYR11.50) after updating our valuation  parameters in our SOP  computation.  Our target P/Es for the automotive  and  other  businesses  in  our  SOP  valuation  –  at  12.5x  and  10x respectively - are unchanged. The group’s 55% stake in UMW Oil & Gas is valued at the consensus fair value of MYR4.50 and applying a 10% holding company discount.UMW’s share price could be supported by the reasonable 4.6% yield derived from assuming a 67% payout ratio (2013: 75.5%).

Company Profile
UMW is the largest company in the automotive sector and is a component stock of the FBM KLCI. Its 51%-owned subsidiary UMWToyota imports, assembles and distributes  Toyota  and  Lexus  vehicles in Malaysia. UMW owns a 55% stake in  the  listed UMW Oil & Gas.

Source: RHB