1Q14  earnings  disappointed  on  the  back  of  weaker  domestic  sales volumes,  higher  depreciation  costs,  unfavourable  exchange  rates  and start-up  costs  in  regional  markets  combined  with  negative  operating leverage  leading  to  margin  erosion.  We  slash  our  2014/15  earnings forecasts  by  14.1%/13.6%  respectively  and  lower  FV  to  MYR5.60.  We prefer Berjaya Auto (BAUTO MK, BUY, FV: MYR2.55). Stay NEUTRAL.

• Tepid  1Q14.  Tan  Chong  reported  tepid  1Q14  earnings.  Revenue  fell 6.9% and 12.3% q-o-q and y-o-y respectively to MYR1.26bn. This was on the back of weaker domestic Nissan and Renault volume sales that declined 10.9% q-o-q and 18.7% y-o-y to 11,976 units.  EBIT margin for the quarter fell to 5.7%  vs 7.9% in 4Q13 (1Q13: 8.9%).  Net profit for the quarter fell 38.9% q-o-q and 50.7% y-o-y  to MYR41.5m.  Earnings for the quarter  were  below  expectations,  reaching  just  14%  of  our  previous estimate and 13% of consensus forecast.  Margin compression was due to  a  combination  of  factors,  including  negative  operating  leverage resulting from the decline in sales volume. Tan Chong also suffered from higher  depreciation  costs  arising  from  the  Danang  plant  in  Vietnam, higher average JPY/MYR exchange  rates and ongoing start-up losses in Indo-China.  Domestically,  management  also  reports  higher  marketing costs as a result of a more competitive trading environment.
• Challenging outlook. Tan Chong’s Indo-China business is not expected to break even until 2015. Nissan sales should pick up in 2H14, helped by the launch of the new C-segment  Sylphy  (April) and D-segment  Teana (June).  Competition  in  the  B-segment  is  increasingly  fierce,  with  the recent introduction of the Toyota  Vios  and Honda  City.  The  completely knocked  down  (CKD)  Serena  Hybrid  is  scheduled  for  launch  later  this year, while the promising Note Hatchback will only arrive in 2015.
• Risks and forecasts. The key risks are weaker-than-expected consumer discretionary  spending  and  continued  losses  in  Indo-China.  Our  2014 and 2015 forecasts are lowered by 14.1% and 13.6% respectively after cutting our volume forecasts and margin assumptions.
• Investment case.  Macro conditions for consumer spending on big-ticket items will remain difficult.  Competition among the Big Three non-national players will remain stiff.

Source: RHB