2016 will be another tough year for UMW. Reiterate SELL and a MYR5.00 TP (31% downside). Its key auto and O&G divisions remain in the doldrums on the back of the collapse in the MYR, crude prices and consumer sentiment. The legacy non-core O&G businesses will likely remain a drag on earnings. Local and foreign institutional interest in the stock is high with street estimates too optimistic.

Grim outlook for auto sales. The macro environment for auto sales in 2016 looks grim. With consumer sentiment at an all-time low according to MIER’s Consumer Sentiment Index (at 3Q15) and higher car prices in 2016 resulting in consumers bringing forward their purchases of cars into4Q15, the outlook for auto sales is challenging. The stronger-thanexpected 4Q15 sales are not a cause to be hopeful in 2016. Competition in the industry remains cutthroat, with a weak MYR contriving to pressure margins. Only the models (Hilux, Fortuner and Innova) on Toyota’s innovative international multi-purpose vehicle (IMV) platformare scheduled to be launched in 2Q16 and 3Q16, with no other new passenger car model launch until late 2016.

Upstream O&G still in a structural downturn. Crude oil prices are still breaking new lows and with no recovery in sight, we see rising risks for impairment charges at UMW Oil and Gas. Given the weak outlook for the industry, the probability of turning around the loss -making non-corebusinesses appears remote – short of the Board biting the bullet and cutting losses on these legacy investments. 2015 was a good year for heavy equipment sales, but the outlook is more uncertain this year. The aerospace manufacturing initiative is promising but contains significant execution risks.

Risks. Upside risks to our recommendation and target price includes a rebound in the MYR, improvement in consumer sentiment, introduction of attractive new models, higher crude oil prices and a turnaround at the various legacy non-core O&G businesses.

Maintain SELL. We tweak our 2015-2017 earnings forecasts higher by 2.7%, 12.6% and 14.5% respectively but leave our SOP-derived TP unchanged at MYR5.00. We see few reasons to change our bearish view on the stock at this juncture. In addition to operational challenges, shareholders are likely to see a cut in dividend, with a real risk of the stock falling out of the FBM KLCI component list at the next review in May. Foreign shareholding is still substantial at about 14%. SELL.

A Bleak Year Ahead The wheels are coming off After a difficult 2015 for Toyota – during which it likely lost its crown as the leader in the non-national segment to Honda (official MAA auto sales data for Dec 2015 will be announced next week) – the outlook for 2016 is no prettier.

2016 will be another difficult year for the auto industry. Lacklustre demand from weak consumer sentiment has given rise to severe price competition in the market place. The Malaysian Institute of Economic Research’s (MIER) Consumer Sentiment Index for 3Q15 stands at an all-time low of 70.2. Aggressive sales and marketing promotions throughout the year are now the norm to entice customers. Despite the hard sell, total industry volume (TIV) for 11M15 still declined 0.8% YoY to 597,234 units. We expect that 2015 TIV reached 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. UMW announced that 2015 sales (Toyota and Lexus) reached 95,861 units, implying sales of 13,469 units in December – which is a new monthly record.

The sales spurt in Dec 2015 will be unsustainable and would come at the expense of new vehicle demand in 2016. Consumers may also have to adjust to higher selling prices beginning 1 Jan 2016, with Toyota list prices rising by up to 7%. The bright side was that the tax exemption for locally-assembled hybrid vehicles was extended into 2016. The list price for the Camry Hybrid remained unchanged. The likelihood of selling prices being revised lower in the foreseeable future is remote, given that the MYR is expected to continue trading with a weak bias against the USD. We expect Toyota sales to contract 6% YoY in 2016. The new model pipeline in 2016 consists mainly of the models built under the Toyota IMV shared platform and includes the Hilux pick-up truck, Fortuner sport utility vehicle (SUV) and Innova multi-purpose vehicle (MPV) that is expected to be launched in April, June and August respectively. An updated Toyota Vios could be introduced toward the latter part of 2016. Compared against new models from main competitor Honda that could include a revised Accord and the all new 10thgeneration Civic, Toyota could be on the back foot this year from a new product perspective.

Uncertain prospects for the heavy equipment business The heavy equipment division was a bright spot for UMW during the 3Q15 period on the back of higher sales to Myanmar (jade mining) and Papua New Guinea. While management remains hopeful that the pace of equipment sales can continue into 2016, the weak price outlook for commodities is a worry. The political changes in Myanmar following the recent elections could also give rise to policy uncertainty.

What was once a jewel in UMW’s stable of businesses that culminated in the IPO of UMW Oil & Gas (UMWOG) (UMWOG MK, NR) in 2013 has now fallen on hard times. Post-IPO, UMWOG expanded rapidly to build up the biggest domestic fleet of premium jack-up rigs. However, the collapse in crude oil prices since mid-2014 has left UMWOG’s business prospects in tatters with the upstream oil & gas segment the most severely affected. At UMWOG’s main drilling services division, daily charter rates for its rigs have fallen off from a peak of above USD160,000 to below USD100,000. New rig charters have been scarce and half its fleet is without a contract. NAGA 2, 3, 5 and 6 are idle. While cold-stacked rigs only operate with a skeleton crew, parking fees, finance costs and depreciation charges continue to accrue. In particular, we expect to see impairment charges in the coming quarter that will have a significant impact not oly on UMWOG’s earnings but also at parent UMW, considering its fixed assets of USD6.6bn. Of the other rigs that are employed, only NAGA 1 (semi-submersible) is on a long-term contract with NAGA 7 and 8 operating on short-term charters while NAGA 4 is coming up for renewal.

New aerospace component manufacturing business Last August, UMW announced an agreement with Rolls Royce Plc to manufacture and assemble aerospace products. The agreement will incorporate Malaysia within its supply chain in South-East Asia, where UMW will build a facility capable of producing, manufacturing, assembling and supplying fan cases for Rolls Royce’s Trent 1000 engines. The Trent 1000 powers the Boeing 787 Dreamliner and enjoys a 42% share of the jet’s engine market. UMW is building a new manufacturing facility in Serendah, with product deliveries expected to begin in 2H17. While we have yet to factor any contributions from this new business into our model, we note that execution risk is high – given UMW’s lack of experience and track record in aerospace component manufacturing. However, the longer-term potential is positive, opening doors to more high value-added precision manufacturing activities going forward

Source: RHB Research - 18 Jan 2016