SIME’s 9MFY23 results disappointed. Prolonged margin compression at its auto business in China negated brisk equipment sales particularly in Australia on its economy reopening, and commodities boom. Hence, we cut our FY23-24F net profit forecasts by 13% and 9%, respectively, reduce our TP by 8% to RM2.40 (from RM2.60), but maintain our OUTPERFORM call. The stock offers a dividend yield of >5%.

9MFY23 results disappointed, making up only 59% and 64% of our fullyear forecast and the full-year consensus estimate, respectively. The key variance against our forecast came from prolonged margin compression at its auto business in China. No dividend was declared for the quarter as SIME typically announces half-yearly dividends.

YoY. 9MFY23 revenue rose 11% as both its core industrials (+6%) and automotive (+13%) segments recorded strong sales. Its industrial division saw an expanding order backlog of RM4.7b (+19%) riding on high commodity\ies prices. There was pent-up demand for maintenance works (due to supply-chain disruptions previously) while prices for parts were higher (translating to better margins) in Australasia. Also helping, was brisk equipment rental business at newly acquired Salmon Australia which has also received positive market response.

Meanwhile, its automotive division sold 84,582 units (+13%) across all markets as the global economy reopened. In terms of geographical regions, Malaysia was buoyed by strong SST-exempted order backlogs, while in other markets such as Singapore, Thailand, China and Australasia, sales were driven up by electric vehicles (EV).

The automotive division reported lower profit margin of 2% compared to 4% a year ago. Meanwhile, the industrial division recorded higher margin of 6% compared to 5% a year ago.

9MFY23 core net profit fell 15% on heavy discounting to gain market share in China, especially in the EV segment with multiple brands actively launching new EV models. This was partially mitigated by strong margins in mining equipment.

QoQ. 3QFY23 revenue rose 2% as marginal weakness in industrials segment (-2%) was cushioned by stronger automotive segment’s sales (+4%) on China’s reopening. Stable margin of 6% at its industrial division was negated by weak margins at the automotive division, translating to a 1% decline in core net profit.

The key takeaways from its results briefing are as follows:

1. SIME guided for mid-single-digit margins for the industrial division with the upwards revision in equipment parts price since June 2022 by the principal. SIME holds the view that coal prices will remain stable, driven by strong demand on economies reopening. Additionally, metals used in the production of batteries for electric vehicles such as lithium, cobalt, nickel, graphite, manganese, copper and aluminium, could be poised for an extended up-cycle. This should drive after-sales and products support which fetch higher margins compared to equipment sales. We are keeping our industrial margin assumption at 5.6% for both FY23 and FY24.

2. SIME shared that heavy price discounting in the automotive market in China will not go away anytime soon especially with the recent significant price cuts by Tesla in China, coupled with the proliferation of new local electric vehicle brands offering low-entry price points. SIME is currently in negotiation with its BMW principal in China for better distribution margins. Elsewhere, SIME is bullish on the South East Asia market (Malaysia, Indonesia, Thailand, and Singapore) where its new EV launches have been well received. It is looking to roll out higher-margin all-new models of BYD Seal, BMW i7 M70L and BMW i5 full electric.

3. SIME is also bullish on the mining and construction sectors in Australia. The resumption of coal exports to China coupled with the general uptrend in commodity prices will boost capex in the resource sector, driving equipment sales and demand for maintenance services. In January 2023, China ended a ban on Australian coal after more than two years. Premium grade Australian metallurgical coal will attract buying interest from China’s coastal steel mills.

Forecasts. We cut our FY23-24F net profit forecasts by 13% and 9%, respectively, to account for prolonged margin compression at its automotive segment, particularly, in China (which typically accounts for 50% of its automotive revenue). We lower our automotive margin assumptions to 2.0% and 2.6%, from 2.3% and 3.0% for FY23 and FY24, respectively.

Consequently, we cut our SoP-derived TP by 8% to RM2.40 (from RM2.60) (see Page 3). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 5).

We like SIME for: (i) the robust growth in its businesses, riding on the economy reopening, (ii) the strong brands under its stable such as BMW, Caterpillar, and (iii) its attractive dividend yield of >5%. Maintain OUTPERFORM.

Risks to our call include: (i) governments cutting back on infrastructure spending on austerity drive and/or a slowdown in the mining sector, hurting demand for heavy equipment, (ii) consumers cutting back on discretionary spending (particularly big-ticket items like new cars) amidst high inflation, and (iii) persistent disruptions (including chip shortages) in the global automotive supply chain.

Source: Kenanga Research - 25 May 2023