2016 looks set to be a difficult year for the auto industry that is beset by tepid consumer sentiment, a competitive market place and a weak MYR forcing many distributors to raise selling prices. TIV in 1Q16 may shock on the downside after buyers advanced their purchase decisions to avoid higher prices. Sector margins will remain under pressure, with headwinds overwhelming and risks weighted on the downside. Maintain UNDERWEIGHT.

Robust 4Q15 sales as consumers rush to avoid price hikes. We understand that total industry volume (TIV) in 2015 reached about 665,000 units (2014: 666,465 units). This implies strong sales in Dec 2015 that reached 68,000 units (+5% YoY), bringing 4Q15 sales to 180,000 units (+3% YoY). Meanwhile, 2015 TIV looks to have surpassed our 650,000 unit forecast from consumers bringing forward their purchase decisions in the bid to avoid the higher prices implemented by some distributors effective Jan 2016 due to the weak MYR.

2016 will be another challenging year for the auto industry . We see a difficult year ahead for companies in the sector. Sentiment continues to wane as consumers become increasingly cautious of committing to bigticket discretionary spending given the rising cost of living. The sharp decline in the MYR could manifest itself in 2016 in the form of higher car prices that consumers will take some time to adapt to. We believe there is a low probability that USD/MYR may be able to strengthen above MYR4.00 this year, with RHB forecasting an average rate of MYR4.34. Margins would remain under pressure in an increasingly competitive market place, while price-sensitive consumers may demand for the best deal and could decide to trade down, diluting the model mix. National auto manufacturers will not be immune, as the middle -income target market is especially susceptible to spikes in the cost of living.

Key risks. Risks to our call include a strong recovery in the MYR and a sharp sustained improvement in consumer sentiment, both of which are not in our base case assumption.

Maintain UNDERWEIGHT. We see few re-rating catalysts for the auto sector in 2016. Headwinds remain overwhelming with few positives to highlight. Accordingly, we expect TIV to contract further in 2016 to 640,000 units. The outlook for demand and profit margins remains challenging in the face of weak sentiment. Risks remain weighted on the downside. We have three SELL calls and two NEUTRAL ones. Our sole BUY call is on Berjaya Auto, the distributor of Mazda cars in Malaysia and Philippines. We also have a SELL recommendation on UMW, the largest stock in the sector by market cap. Maintain UNDERWEIGHT on the sector.

Winter Is here Lacklustre 9M15 earnings for the sector As expected, most of the auto stocks reported Sep 2015 quarter earnings with a weak bias and common themes include unfavourable forex movements, price competition and weak overall demand, all combining to hurt revenue and crimp margins. Berjaya Auto (BAUTO MK, BUY, TP: MYR2.40) is now our only BUY recommendation in the sector on account of its strong product pipeline, expectations of further gains in market share from a small base and compelling product range. It also enjoys a partial shield from further MYR weakness and trades at undemanding valuations.

Flat auto sales in 2015 despite heavy discounting The lacklustre demand from weak consumer sentiment has given rise to severe price competition in the market place. Auto distributors have introduced aggressive sales and marketing promotions to entice customers. Despite the hard sell, total industry volume (TIV) for 11M15 still declined 0.8% YoY to 597,234 units. We understand that 2015 TIV will reach about 665,000 units (2014: 666,465 units), implying robust 4Q15 sales that reflect car buyers advancing their purchase decisions to avoid the price increases implemented by many auto distributors beginning 1 Jan 2016 to reflect the weaker MYR.

A challenging year ahead We see a difficult year ahead for companies in the sector. Sentiment continues to wane as consumers become increasingly cautious of committing to big-ticket consumer discretionary spending, given the rising cost of living. The sharp decline in the MYR could manifest itself in 2016 in the form of higher car prices. The MYR is one of the worst-performing currencies, having declined 22.8% and 22.2% againstthe USD and JPY respectively. We expect the MYR to stay weak through much of 2016 on the back of concerns over China’s economy and currency in addition to weak global crude oil prices and higher US interest rates. Distributors could also seek financial support and assistance from their respective principals that could help ease the pain. Non-national market leaders – Toyota, Honda, Nissan and Mitsubishi –have all indicated that car prices will rise next year. Weak demand and higher prices could contrive to dampen car sales in 2016. Margins may continue to come under pressure from consumers who are increasingly price-sensitive. National auto manufacturers will not be immune, as the middle-income target market is especially susceptible to spikes in the cost of living. Expanded dealership networks enable the consumer to shop around for the best deals. Consumers also expect a combination of a free servicing package, extended service warranty and other freebies to sweeten the deal. We also expect to see some down-trading, where consumers opt for a cheaper model instead e.g a Honda Civic instead of an Accord. These factors could pressure profit margins. The availability of financing could also be a bottleneck for auto sales, with lenders concerned with maintaining credit quality given the elevated household debt. The high price of cars relative to income is also a factor limiting the headroom for growth in auto sales.

Evolving consumer preferences Distributors who are able to schedule a steady stream of well-priced, new face-lifted models would be able to enjoy balanced sales volumes. Companies with gaps in their launch schedule could lose market share to newer competitors. Consumers continue to gravitate to the latest and greatest models. Models more than two years old would typically see sales volumes drop off sharply, unless there is a comprehensive facelift. Distributors who can quickly implement a local assembly programme would be able to lower their selling prices and enjoy improved sales volumes.

Key risks Risks to our call include a strong recovery in the MYR and a sharp sustained improvement in consumer sentiment, both of which are not in our base case assumption. Macro factors influencing the sector include regulatory changes, forex trends, the availability of financing, consumer behaviour patterns and consumer sentiment.

Maintain UNDERWEIGHT We see few re-rating catalysts for the auto sector in 2016. Headwinds remain overwhelming, with few positives to highlight. Accordingly, we expect TIV to contract further in 2016 to 640,000 units. The outlook for demand and margins remains challenging and risks remain weighted on the downside. The outlook is for weaker sales, especially in 1Q16, as consumers manage higher living costs, weaker job security and adjust to the higher selling prices.

We maintain our UNDERWEIGHT sector call. We have three SELL calls, twoNEUTRAL. Our sole BUY call is on Berjaya Auto, the distributor of Mazda cars in Malaysia and Philippines. We also have a SELL recommendation on UMW, the largest stock in the sector by market cap.

Source: RHB Research - 12 Jan 2016