We recently visited UMW’s assembly plant in Shah Alam, Assembly Services Sdn Bhd (ASSB), where we met the management to obtain additional information on its upcoming new plant and operations of the current plant. We are cautiously optimistic on UMW’s new plant as it will 1) increase operating efficiency, 2) increase capacity and 3) allow introduction of new CKD models. Furthermore, after the upcoming deconsolidation of its oil and gas (O&G) arm, UMW should have ample capex to fund construction of the new plant. However, we remain bearish on UMW’s prospects given the unfavourable outlook on the automotive industry. Furthermore, its unlisted O&G assets remain a major drag on earnings. Maintain Sell on UMW with unchanged TP of RM4.05 based on SOP valuations.

Plant operation takeaways

UMW’s existing plant currently has capacity of 76k units p.a and is built on a land area of 32 acres. Currently, due to poor Toyota sales, it is currently running at only 60%-70% utilisation rate. During our visit, the plant’s takt time (the maximum amount of time in which a product needs to be produced in order to satisfy customer demand) stood at 11 mins. According to management, this duration is rather slow as the plant’s highest efficiency rate is circa 5 mins takt time. We note that Toyota’s plant operates with the ‘just in time’ method where inventories are kept for a maximum of 4 hours in the assembly plant. Hence, this reduces the need for storage space.

Current plant not optimal

Following our observation of the current plant’s operations, we believe construction of a new plant is necessary and long overdue. Land usage at the existing plant’s site of 70% has exceeded its optimal level of 60%. Furthermore, we note that the assembly lines seem to be running below optimal rates and have a rather complicated structure. The latter is because the existing plant assembles 6 different models for both the passenger and commercial segments. The new plant will allow UMW to streamline the assembly process, thus, increasing efficiency and capacity significantly. We understand that the existing plant currently has 2,670 employees. After the new plant is built, the headcount may increase only slightly, or not at all, due to increased efficiency and automation. To recap, the new plant will have initial capacity of 50k units pa., which can later be ramped up to 100k units pa. Management also shared that ground works for the new plant has started.

New introduction of CKD models

The new plant will allow UMW to provide more CKD models. In our opinion, Toyota’s CKD model lineup is lacking as it does not even have a C-segment sedan in its lineup. On top of that, it is lacking models in the SUV segment. On the other hand, Honda, its main competitor has 7 models in the passenger segment covering all classes in the SUV and sedan segment. This included the Accord, City, Civic, BR-V, CR-V, HR-V and Jazz. Thus, we believe Toyota is currently outclassed by its main competitor in terms of CKD model line-up.

New plant possible re-rating catalyst

Our back-of-the-envelope calculations (Figure 1) suggest that the new plant will contribute circa RM25.4mn in its first year of operations and RM177.6mn in its second year of operations. Our calculations are based on the following assumptions for 1st/2nd years: 1) average ASP 94.6k/94.6k, 2) USD/MYR rate of 4.25/4.25, 3) local content of 65%/70%, 4) annual capacity of 50k/50k units and 5) utilisation rate of 20%/60%. We believe the successful launch of the new plant will be a major re-rating catalyst for UMW in the future. This is on the back of higher volumes, localization, and cost savings from streamlining of models. However, at the moment, we maintain our recommendation and earnings forecasts.

Recent EEV status gained

During the meeting, management shared that the Toyota Fortuner recently qualified as an EEV (energy efficient vehicle). Subsequently, the retail price was reduced up to RM16k depending on the variant. The Fortuner is the first 4X4 SUV to receive the EEV status and joins the Vios, Camry and recently launched Innova. To recap, a model that qualifies as an EEV will incur reduced excise duties. EEV qualification is given on a case by case basis and takes into consideration fuel efficiency of the model, localisation of contents and transfer of technology. We opine that the hefty reduction in price is a key selling point and will attract customers. Going forward, we expect management to apply for EEV status for additional models.

Outlook still unexciting

UMW’s outlook going forward looks rather bleak. Its Rolls Royce plant in Serendah is expected to be begin operations in 2017 but will likely only contribute to earnings in 2018. Furthermore, we do not expect the contribution to be large. To recap, we expect the plant to contribute circa RM30mn pa. Additionally, its new automotive plant will only begin operations in 2019. Demand for its cars is still uncertain given the poor outlook on the automotive sector. On the bright side, its proposed deconsolidation exercise will remove a heavy drag on earnings.

Valuation

Although the proposed deconsolidation exercise will remove a heavy drag on earnings, we believe UMW’s core automotive business will continue to flounder in the near to medium term. Hence, we maintain our Sell recommendation with TP of RM4.05 based on SOP valuation. We also maintain our earnings forecasts pending completion of deconsolidation exercise.

Source: TA Research - 7 Feb 2017