While earnings will crater in 2014 after being hit by operational issues in Vietnam  while  its  domestic  business  was  adversely  impacted  by changes  in  the  competitive  landscape,  2015  will  likely  be  another challenging year.  Upgrade to NEUTRAL  (from Sell)  with  a  MYR3.10  TP (6.1% downside). The new X-Trail SUV will be a welcome boost although management will be focusing on deleveraging its balance sheet.

A disastrous 2014. This has been a washout year for Tan Chong Motor (Tan  Chong).  The  domestic  competitive  landscape  shifted  with  the launch of all new B-segment models by Toyota and Honda that helped them  to  regain market  share  lost  to  the  Nissan  Almera  in  2013.  The customs  dispute  in  Vietnam  (since  resolved  in  August)  has  set  back production at its Danang plant from the lack of parts and components.

New  X-Trail  a  welcome  boost.  Tan  Chong  will  launch  the  all  new Nissan  X-Trail  sports utility vehicle (SUV)  in early 2015 that will plug a major  gap  in  its  flagging  model  line-up  domestically.  It  is  targeting monthly  sales  of  400-500  units  of  the  new  SUV.  Tan  Chong  will introduce a facelift Almera and a new Navara pickup truck in 2015.

Asset light in 2015.  Tan Chong  is reassessing  its  business model. We understand  that  management  intends  to  relieve  the  pressure  on  its balance sheet by reducing demands on working capital and scaling back on capex plans. This could involve a structural shift toward an asset light business  model  involving  the  elimination  of  some  significant  capital assets off the balance sheet and running down inventory levels.

Risks.  About  60%  of  its  manufacturing  cost  of  sales  is  transacted  in foreign  currency  (80%  in  USD).  Continued  USD  strength  will  crimp margins  that  will  not  be  offset  by  a  weaker  JPY.  Other  risks  include slower-than-expected  economic  growth,  weaker  consumer  sentiment, higher interest rates and a severe tightening of financing.

Investment case.  We trim our 2014-2016 recurring net profit forecastsby 4.8%, 12.8% and 13.6% respectively. While  its  absolute forward P/E valuations are not especially appealing, we think the share price will be supported  by  the  21.6%  discount  to  historical  book  value/share. Accordingly,  we upgrade our call to NEUTRAL (from Sell) after trimming our  TP  to  MYR3.10  (from  MYR3.55)  derived  from  ascribing  an unchanged 11.5x target P/E (in line with peer average) to 2015 earnings.

Still Some Potholes To Navigate 2015

A disastrous 2014.  2014  has been a washout  year for Tan Chong. The  domestic competitive  landscape  shifted  with  the  launch  of  all  new  B-segment  models  by Toyota and Honda that helped them to regain market share lost to the Nissan Almera in 2013. Although Tan Chong has had to sacrifice margins to shift product, Nissan was the worst performing non-national marque this year with 11M14 sales volumes declining  15.4%  YoY  to  just  41,088  units.  The  customs  dispute  in  Vietnam  (since resolved in August) has set back production at its Danang plant,  as it has not been able to import parts and components for the best part of the year. This  culminated  in a USD4.6m inventory provision and a MYR38m pre-tax loss for 9M14 at 74%-owned Nissan Vietnam (NVL).

New X-Trail a welcome boost. Tan Chong is expected to launch the all new Nissan X-Trail  SUV in early 2015 that will plug a major gap in its flagging model line-up in Malaysia.  The  company  is  targeting  monthly  sales  of  400-500  units  of  the  new  XTrail. We are also expecting Tan Chong to introduce a face lift Nissan  Almera  and a new Navara  pickup truck in 2015.  Nonetheless, even with the new model, the X-Trailwill be up against stiff competition from the class leaders, Mazda’s CX-5 and Honda’sCR-V,  which  have  achieved  monthly  sales  of  550  units  and  587  units  during  the 6MFY15 (Apr) and 11M14  periods  respectively.  Despite next year’s  Almera  facelift, Nissan  still  lacks  a  model  to  be  really  competitive  in  this  segment,  with  Mazda’s eagerly  awaited  2  launching  in  Jan  2015  in  hatchback  and  sedan  versions. Management’s guidance is that the Nissan Note hatchback is unlikely to be launched in Malaysia for pricing and competitive reasons. 

Asset light in 2015.  Tan Chong  is reassessing  its  business model. We understand that  management  intends  to  relieve  the  pressure  on  its  balance  sheet  by  reducing demands  on working capital and scaling back on capex plans. This could involve a structural shift toward an asset light business model involving the elimination of some significant capital assets off the balance sheet  and running down inventory levels. A rethink of its dealership strategy could also be under consideration. Peers like Honda and Mazda mainly employ an independent dealer network to distribute their vehicles. In  addition  to  reduced  administrative  costs,  this  approach  could  also  help  to incentivise  its  sales  force.  While  its  Segambut  land  totalling  about  47  acres  has significant development potential, it is currently occupied by its main assembly plant. In time, this property could be redeveloped,  but we think this is unlikely to happen in the foreseeable future.

Risks.  About  60%  of  Tan  Chong’s  manufacturing  cost  of  sales  is  transacted  in foreign currency, of which 80% is in USD. Continued USD strength will crimp margins that  will  not  be  offset  by  a  weaker  JPY.  Other  risks  include  slower -than-expected economic  growth,  weaker  consumer  sentiment,  higher  interest  rates  and  a  severe tightening of financing.

Investment case.  After revising our Nissan sales volume assumptions, we trim our 2014-2016 recurring net profit forecasts by 4.8%, 12.8% and 13.6% respectively. We see  another  tough  year  for  Tan  Chong  in  2015  in  the  absence  of  a  compelling  B Segment  product  despite  the  face  lift  for  the  Almera  scheduled  in  2015.  Nissan’s products  in  Malaysia  will  likely  continue  to  compete  more  on  price  and  less  on product  appeal.  While  Tan  Chong’s  absolute  forward  P/E  valuations  are  not especially  appealing,  we  think  the  share  price  will  be  supported  by  the  21.6% discount to historical book value/share. 

Source: RHB