UMW’s  2014  earnings  disappointed  once  again  after  provisions  and losses  from  its  legacy  non-core  oil  and  gas  businesses  contrived  to drag earnings lower,  although its core divisions performed in line with expectations. We downgrade to SELL (from Neutral)  and cut our TP to MYR9.65 (12% downside) from MYR11.00. Prospects for the year ahead look challenging, with its businesses facing headwinds on all fronts.

Non-core O&G  unit  drags  earnings.  UMW reported weak earnings in 4Q14 (net profit fell 57.8% QoQ  and 23.8% YoY). Reported net profit for the  year  declined  3.5%  YoY to  MYR657.7m  and  reached  only  75%  of our estimate. The main cause of the deviation came from a 4Q14 pre-tax loss  of  MYR184.1m  at  its  “Others”  division  –  a  motley  combination  of disparate legacy non-core oil & gas assets that were  left out of the 2013 listing of UMW Oil & Gas (UMWOG) (UMWOG MK, NR).   Management’s insistence  on  attem pting  to  turn  around  these  loss-making  businesses has  yet to bear fruit. Its other business divisions  reported earnings that were broadly in line with expectations. A third interim DPS of 16 sen was declared, bringing the total 2014 DPS to 41 sen (2013: 44 sen).

Core businesses performed in line. Revenue at its automotive division only rose 5% YoY in 2014,  despite Toyota sales growing 12%,  implying a less favourable sales mix and some aggressive marketing strategies. The  equipment  division  reported  a  13.7%  YoY  pre-tax  profit  growth helped  by  higher  overseas  sales.  Revenue  and  pre-tax  profit  at  55%-owned  subsidiary UMWOG rose 38% and 39.3% YoY respectively,  after additional  contributions  from  newly-deployed  assets  were  imputed. There  was  a  full-year  contribution  from  NAGA-4  and  part  year contributions from NAGA-5 and NAGA-6.

Risks and forecasts.  The main risks are unfavourable exchange rates, weaker  consumer  sentiment  and  lower  oil  prices.  After  updating  our assumptions,  we trim our 2015-2016 earnings estimates by 13.6% and 12.5% respectively. We also introduce our 2017 forecasts.

Challenging outlook. We expect  UMW’s businesses  to face   quickening headwinds in 2015.  Its auto business may  be adversely  affected by the stronger  USD,  more  cautious  consumers  and  greater  competition  after losing its non-national passenger vehicle crown to Honda in 2014. Weak commodity prices may  deter spending on new equipment while lower oil prices  would  slow  activity  in  the  engineering  and  procurement  (E&P) arm,  with  pressure  on  charter  rates  and  equipment  utilisation.  With valuations looking stretched and a downside risk to earnings, downgradeto SELL, with a lower SOP-derived TP of MYR9.65 (from MYR11.00).