UMW’s auto business stays in low gear

This article first appeared in The Edge Malaysia Weekly, on November 5, 2018 - November 11, 2018.
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AFTER eight months in a holding pattern, UMW Holdings Bhd has finally ended its pursuit of majority control of Perusahaan Otomobil Kedua Sdn Bhd (Perodua).

The idea was to turbo-charge its automotive segment in a soft market. Without the Perodua boost, that division looks set to remain in low gear in the short term.

Looking ahead, UMW’s recovery from some of its more difficult financial years will likely be at a slower pace than it wants.

Its auto business is by far the largest driver of earnings annually, making up at least 72% of group turnover in the last five years (before the demerger of its listed oil and gas business). In its financial year ended Dec 31, 2017 (FY2017), that proportion rose to a 13-year high of 80.3%.

Thus, its group financial performance remains tied to the fortunes of its automotive division, which comprises an exclusive distributorship of Toyota and Lexus models in Malaysia, and a 38% stake in Perodua, which yields associate income.

The two components of the division have had contrasting fortunes in recent years as the domestic automotive sector cooled.

After a record 666,677 units in total industry volume (TIV) in 2015, the figure fell sharply by 13% to 580,085 in 2016, according to the Malaysian Automotive Association. TIV eased further to 576,635 units last year.

Perodua became more dominant in the same period. Its market share rose from 29.3% in 2014 to 35.7% in 2016. It was 35.6% last year.

However, UMW’s non-Perodua market share fell for two consecutive years from 15.5% in 2014 to 11.2% by 2016, when industry TIV plunged.

That coincided with UMW’s worst annual financial performance on record, posting a net loss of RM1.66 billion on revenue of RM10.96 billion.

To be fair, the main drag was its listed and unlisted oil and gas businesses, which were struggling in a low crude oil price environment.

UMW has since demerged its listed oil and gas business — now known as Valesto Energy Bhd — and written off the rest. Adjusted to exclude the demerged unit, its FY2016 net loss is RM536.5 million on revenue of RM10.44 billion, according to its FY2017 annual report.

While last year saw UMW’s Toyota and Lexus sales volume improve to 70,445 units from 65,110 in 2016, this may have been at the expense of squeezed margins.

Data compiled by Bloomberg indicates that the automotive segment’s full-year pre-tax margins shrank from as high as 16% in FY2011 to just 4.8% in FY2017.

This somewhat explains why UMW set its sights on Perodua — an increase to majority shareholding would give it strategic control and a bigger share of earnings.

For perspective, Perodua’s standalone profitability is almost comparable to UMW’s as a group. In 2016, Perodua raked in RM463.59 million in net profit on revenue of RM9.05 billion and paid RM205.94 million in dividends to its shareholders.

Apart from UMW, other Perodua shareholders are listed automotive group MBM Resources Bhd (22.58%); UMW’s own majority shareholder Permodalan Nasional Bhd (10%); and technical partner Daihatsu Motor Corp (the remaining 29.5% or so).

Back in March, UMW offered RM2.56 per share for a 50.07% stake in MBM Resources to gain control of the latter’s Perodua stake. UMW also separately offered the same price for PNB’s stake in Perodua.

However, its offer was deemed too low despite being at a 13.3% premium to the market value of MBM Resources at the time.

UMW’s offer sparked a prolonged internal shareholder tussle within Med-Bumikar Sdn Bhd, which owns the 50.07% stake in MBM Resources, over whether to reject the offer outright or renegotiate a higher price.

In addition, Daihatsu Motor vehemently opposed the intended Perodua takeover, even threatening to walk away if UMW continued.

While UMW would not budge on the offer price, it eventually gave Med-Bumikar up to Oct 30 to sort out its position and decide on the offer. The validity period lapsed last week without an acceptance.

For UMW, the failed attempt closes one shortcut to a faster uplift in its automotive segment’s near-term financial performance.

Had the Perodua acquisition gone as intended, the full-year consolidation would have boosted UMW’s earnings per share by 14% beginning FY2019 despite a short-term dilution in FY2018, says Kenanga Research in a March report.

Its other trump card is its new Bukit Raja plant, scheduled to come online from the first quarter of 2019. The RM1.87 billion facility is designed for an initial capacity of 50,000 units annually, which may be increased to 100,000.

That will essentially double UMW’s overall capacity. But analysts are mixed on the likely impact of the new plant.

From the industry perspective, MAA is forecasting a higher TIV of 585,000 for this year, which would mark the first uptick in three years. UMW is targeting 70,000 units of Toyota and Lexus sales but is hopeful of exceeding the mark.

The new plant will allow UMW to assemble more Toyota models, which may help sales — MIDF Research sees this year as an “inflection point”.

“We forecast Toyota TIV to rise 13% year on year to 81,000 in FY2019 and market share to expand to close to 14% in FY2018 from 12%. This is expected to be driven by the new Vios and, more importantly, the all-new Yaris (Honda Jazz’s competitor), which fills a major gap in UMW’s model mix,” says the research house in an Oct 31 report.

However, an analyst tells The Edge that higher capacity does not automatically guarantee higher sales.

On Nov 1, Hong Leong Investment Bank also flagged some concern that start-up costs in terms of low utilisation may offset better efficiency at the new plant.

This year, a brief sales uplift from the tax holiday period following the change in federal government is expected to be offset by a sales drop from the reintroduction of the sales and services tax (SST) in September.

UMW’s third-quarter results, due in end-November, will provide important signals to how significant the SST impact was to its sales.

That said, more sell-side analysts are feeling better about the stock. On Nov 1, three out of eight analysts who updated their coverage of UMW upgraded the stock to “buy” while one downgraded to “sell”.

Overall, 9 of the 17 analysts tracking the counter have a “buy” call and target prices of between RM5.45 and RM6.72. There are six “hold” ratings and two “sell” calls.

Last Thursday, UMW closed at RM4.70 per share, down about 32.4% since its January peak of RM6.95.

Some of that rising positivity may be premised on upcoming launches that may support UMW’s automotive earnings and drive a slow recovery.

Perodua will launch a sports utility vehicle model in the coming months, which analysts say will fill a gap in its model mix.

Meantime, Toyota’s recently launched Rush is locally assembled with higher specifications. It is also rolling out a new Camry in the fourth quarter and a new Vios early next year, which analysts expect will support sales.

“Toyota TIV should rise further to 90,000 in FY2020. UMW is targeting to regain pole position in the non-national segment over the mid-term,” says MIDF.

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