The introduction of  the  GST and its secondary effects on inflation and living costs will  pose additional challenges for the industry on top of a more  competitive  market  place  that  could  shake  up  the  established order and crimp margins.  We remain NEUTRAL on the sector.  Resilient consumption spending and a strong product pipeline will be supportive of auto sales. Berjaya Auto and MBM Resources are our top picks.

Softer 2H14 sales  catch  industry by surprise.  The softer auto sales beginning in 2H14  were unexpected, catching many industry players off guard,  especially  after  a  robust  June  quarter.  11M14  total  industry volume  (TIV)  only  reached  601,785  units  (+1.1%  YoY)  with  sales  for 2014 likely to miss  earlier forecasts  of 675,000 units. It is possible that consumers  are  already  beginning  to  postpone  their  car  purchases  in anticipation of lower car prices post goods and services tax (GST) (as a 6%  GST  replaces  a  10%  sales  tax)  while  others  are  beginning  to postpone big ticket consumer discretionary spending  in anticipation of a less favourable environment in 2015.

A  competitive  market  place.  What  is  clear  is  that  heightened competition in the market is here to stay. Manufacturers have embarked on  a  strategy  to  win  and  retain  market  share  helped  by  a  robust  new model  pipeline.  New  marques  are  entering  the  market  while  existing players are also  expanding their model line-ups into new market niches. Margins will likely remain under pressure.

FX  volatility.  Forex  volatility  will  also  impact  the  sector.  USD  strength will be negative for UMW Holdings and Tan Chong while JPY weakness will  benefit  Berjaya  Auto  (BAUTO  MK,  BUY,  TP:  MYR4.50),  MBM Resources  (MBM MK, BUY, TP: MYR3.55)  and DRB-HICOM  (DRB MK, BUY, TP: MYR2.90).

Sector  risks.  Unexpected  regulatory  changes,  unfavourable  forex trends, availability of financing, unpredictable consumer behaviour an d a weakening of consumer confidence are the main risks.

Maintain NEUTRAL. We expect industry sales volumes to dip slightly to 650,000  units  in  2015  after  experiencing  three  consecutive  years  of higher YoY sales. The implementation of  the  GST, combined with rising living costs, will all contrive to pressure the consumer. On the flip side, overall consumption spending should stay resilient, helped by a strong product pipeline and a competitive marketplace where manufacturers are prepared to discount. These factors should be supportive of auto sales in 2015. We remain NEUTRAL on the sector given the absence of re-rating catalysts. Our Top Pick remains Berjaya Auto, the dstributor of Mazda cars in Malaysia and Philippines. A focused business plan, growth from a small base and compelling product range will enable Mazda cars to gain market share.

Auto Sales To Remain Resilient In 2015

A sluggish quarter

The  Auto  sector’s  most  recent  earnings  disappointed  for  the  seventh  consecutive quarter. Only Berjaya Auto and MBM Resources reported earnings that were in line with expectations. Berjaya Auto is our Top Pick for the sector and we expect Mazda cars to continue gaining market share on the back of a strong product suite helped by sturdy principal support. It is also a beneficiary of the weaker JPY, which will lower cost of sales. 2015 is looking more positive for MBM Resources, with its alloy wheel business targeting to break even from higher plant utilisation rates.

Perusahaan Otomobil Kedua SB (Perodua) should also have a stronger year,  given the encouraging market reception to the new  Axia  model and the lower JPY. APM Automotive  Holdings  (APM)  (APM  MK,  TP:  MYR4.75)  suffered  from  sharply  lower total  industry  production  volumes  during  the  quarter  in  addition  to  pricing  pressure from  original  equipment  manufacturer  (OEM)  customers  that  compressed  margins. The  stock  was  downgraded  to  SELL.  Tan  Chong  Motor  Holdings’  (Tan  Chong) (TCMH  MK,  NEUTRAL,  TP:  MYR3.10)   domestic  business  suffered  from  a  lack of compelling  products,  intense  competition  and  the  need  to  discount  to  reduce inventory, thereby sacrificing margins in the process. Its Indochina venture has been a minefield, given the dispute with customs earlier during the year and compounded by an MYR15m Nissan Vietnam Ltd-related inventory provision during the quarter. UMW  Holdings  (UWMH  MK,  NEUTRAL,  TP:  MYR11.00)  suffered  from  weaker automotive  and  equipment  margins  during  the  quarter  while  its  non-core  oil  &  gas (O&G) businesses remained loss making. DRB-HICOM's core earnings were weak, reflecting dismal Proton sales volumes. The initial marke t response to the Proton  Irizhas been tepid, overshadowed by Perodua’s Axia.

Industry trends

The  ongoing  5-year  plan  by  the  Malaysian  Automotive  Institute  (MAI)  to  lower  car prices by up to 30%  without any changes in the nominal automotive duty structure has seen the domestic auto market racked by fierce competition. Manufacturers have embarked  on  a  strategy  to  win  and  retain  market  share,  helped  by  a  robust  new model pipeline. New marques are entering the market while existing players are also expanding  their  model  line-ups  into  new  market  niches.  Expanded  dealer hip networks also enable the consumer to shop around for the best discount.

Consumers are becoming more price sensitive, with some trading down to cheaper models.  In  response,  auto  manufacturers  are  introducing  more  model  variants  at lower price points. Margins compression has been a key feature this year. Marques with a weaker competitive edge have had to discount to clear inventory to make way for  new  models  and  free  up  working  capital.  Forex  volatility  will  also  impact  the sector. USD strength will be negative for UMW Holdings and Tan Chong while JPY weakness will benefit Berjaya Auto, MBM Resources and DRB-HICOM.

Softer 2H14 sales catch industry by surprise

The  market  downturn  beginning  in  2H14  was  unexpected,  catching  many  industry players  off  guard,  especially  after  a  robust  June  quarter.  In  July,  the  Malaysian Automotive Association (MAA) also nudged up its TIV forecast to 680,000 units (from 670,000  units).  September  quarter  TIV  contracted  8.1%  and  8.8%  QoQ  and  YoY respectively.  Cumulative  11M14  sales  only  rose  1.1%  YoY,  wiping  out  the  robust 6.3% YoY gain seen in 1H14, compounded by the higher base in 3Q13 from pent-up sales post the 13th General Election (GE13). Auto sales in November reached 55,293 units,  up  2.0%  MoM  and  5.8%  YoY.  Tepid  MoM  sales  were  caused  by  seasonal factors coming into play, as vehicle shoppers hol d back purchases in anticipation of year-end discounts from automakers, while others preferred  to register their vehicles in a new year.  During 3Q14, almost all major marques reported a sequential decline in  sales  volumes  with  the  exception  of  Nissan,  a fter  Tan  Chong  resorted  to aggressive price discounting.

There are several theories to explain the unexpectedly  softer sales in 2H14. One is that consumers are already beginning to postpone their car purchases in anticipation of lower car prices post GST (as a 6% GST replaces a 10% sales tax). The second is that national car buyers were waiting for the new Proton  Iriz  and Perodua Axia, both of which were launched in September. A secondary consequence to the launch of the Axia was that production of the volume selling Viva ceased after 2Q14 in anticipation of  the  new  model.  A  third  more  sinister  theory  was  that  consumers  are  already beginning to postpone big ticket consumer discretionary spending in anticipation of higher inflation, rising living costs, lower  disposable incomes and a less favourable environment for consumers post GST in 2015. In our opinion, a combination of the first two factors is closer to the truth,  with consumers and businesses already having 
adapted to fuel price increases, an electricity  tariff hike, higher industrial gas prices and  higher  interest  rates  in  the  past  year.  We  believe  that,  with  price  discounting already  prevalent  in  the  market,  a  car’s  official  list  price  becomes  just  a  nominal number.  The  lower  discounted  street  price  has  become  the  new  “list”  price. Accordingly, we expect that manufacturers will not significantly alter official list prices post GST  as the discounts generally being offered already exceed the 1-3% GSTrelated pricing differential (according to MAI simulations).
 

GST introduction could disrupt consumption patterns

RHB  Economics  is  forecasting  real  GDP  growth  of  5%  in  2015  while  consumer spending will grow 5.2%, albeit at a slower pace (2014F: 6.8%). Domestic demand will  be  supported  by  a  new  investment  cycle,  young  population  demographics  and low  unemployment  levels.  However,  the  impending  introduction  of  the  GST  could disrupt traditional consumption patterns, especially for large consumer discretionary purchases.  This  is  especially  so  if  consumers  take  a  more  cautious  approach  and postpone  spending  until  the  impact  of  the  tax  on  prices  of  goods  and  services  is better understood.  Over  the  course  of  2015,  as  consumers  adapt  to  the  new  GST regime, consumption trends should even out.

Key Risks

Unexpected regulatory changes, unfavourable forex trends, availability of financing, unpredictable consumer behaviour and a weakening of consumer confidence are the main risks. The rising cost of living, inflation and the higher interest rate environment are  also  factors  that  could  limit  consumer  discretionary  spending.  The  elevated household  debt  levels  and  high  price  of  cars  relative  to  incomes  are  significant factors limiting the headroom for growth in auto sales. Howeve r, if the MAI achieves its  goal  of  bringing  down  car  prices  by  up  to  30%  in  the  next  few  years,  then affordability levels will improve with commensurate upside to industry volumes.

Auto sales to remain resilient in 2015

Auto  TIV  has  already  seen  three  consecutive  years  of  higher  YoY  sales.  The implementation of GST, combined with rising living costs, will all contrive to pressure the consumer. On the flip side, overall consumption spending should stay resilient, helped  by  a  strong  product  pipeline  and  a  competitive  marketplace  where manufacturers are prepared to discount. These factors should be supportive of auto sales in 2015. We forecast 2015 TIV to ease to 650,000 units. We remain NEUTRAL on the sector given the challenges ahead. Our Top Pick remains Berjaya Auto, the distributor  of  Mazda  cars  in  Malaysia  and  Philippines.  A  focused  business  plan, growth from a small base and compelling product range will enable Mazda cars to gain market share.

Source: RHB