We attended an engagement session yesterday with the President and Group CEO of UMW Holdings Bhd, Encik Badrul Feisal, to understand the Group’s plans going forward. We left the session feeling slightly more upbeat on the Group’s long-term prospects. Our view is underpinned by 1) sale and deconsolidation of the O&G assets, 2) expansion into high-value manufacturing, and 3) building of new automotive plant. That said, these are long-term goals, and would only come into fruition in 3-5 years. Therefore, we believe short-term prospects remain bleak. We maintain our earnings forecast for now as UMW will be releasing its full-year financial results on 27th Feb. Thus, our Sell recommendation remains with unchanged TP of RM4.05 based on SOP valuation.

Divesting O&G Assets

To recap, UMW recently announced a distribution in specie of its listed O&G arm, UMWOG, to shareholders. From this session, we conclude that the transaction was largely driven by the current O&G industry downturn, which will make it difficult for UMW to pull UMWOG through without strong financial muscle. This was underpinned by heavy capex commitment for its upcoming Roll Royce plant (RM750mn), and the new Toyota plant (RM2bn). Furthermore, management believes that PNB, EPF and Ekuinas, whom have more financial muscle, are in a better position to steer UMWOG through this challenging period. The demerger is expected to be completed by 1HFY17 and will significantly improve UMW’s balance sheet and P&L statement. Additionally, UMW still has unlisted O&G assets that are a huge drag on earnings. To recap, these assets incurred circa RM100mn losses in 9MFY16. In 4Q16, UMW plans to make chunky impairments to reduce the book value of these assets. According to UMW’s 2015 annual report, the current book value of the unlisted O&G assets is RM861.7mn. We believe the potential impairment may be as high as 50% of the current book value, at circa RM430mn. Following the impairment, management expects the unlisted O&G segment’s losses to narrow significantly. UMW also expects to sell off all its unlisted O&G assets by end-18, and is committed to doing so. Recall that UMW’s unlisted O&G assets include 1) land rigs in Oman, 2) pipe manufacturing plants in China, 3) land rigs in India and 4) various other businesses in Australia and Malaysia.

Move to High Value Manufacturing

Construction of UMW’s new Rolls Royce plant in Serendah has been completed, and the machines are currently undergoing commissioning. However, management only expects the plant to contribute positively in 2019, and achieve cashflow breakeven level in 2020-21. To recap, UMW secured a 25+5 year contract with Rolls Royce to manufacture fan cases. We understand that demand for aerospace components is high as Boeing and Airbus typically have 7-8 years order backlog. In future, UMW will seek significantly higher margin manufacturing jobs, such as production of other aerospace components and medical equipment.

Automotive segment to remain weak

As mentioned, UMW plans to build a new plant in Bukit Raja, which is targeted for completion in 2019. This new plant, with initial capacity of 50k units p.a, is highly automated, and would increase operating efficiency significantly. Pending completion of this new plant, it will be challenging for UMW to compete with peers. This is because its current plant is 48 years old and comparatively inefficient. Correspondingly, UMW’s sales forecast for 2017 is 70k units (2016: 65k units). We believe this target may be overly ambitious, given that UMW is expected to launch only one new model this year, versus four last year.

Near-term outlook still bleak

Given sustained earnings headwinds, even post-demerger of its O&G arm, we remain pessimistic of UMW’s near-term prospects. Weak consumer sentiment and stringent HP loan approvals weigh on the automotive segment. Additionally, its new high value manufacturing operations will likely have a prolonged gestation period. Furthermore, its equipment segment is struggling due to new regulations in Myanmar, and floods in East Malaysia. All in, we expect a slow recovery for UMW.

Valuation

We maintain our earnings forecast for now, pending release of UMW’s full year financial results. Hence, we maintain our Sell recommendation with TP of RM4.05 based on SOP valuation.

Source: TA Research - 22 Feb 2017