This article first appeared in The Edge Financial Daily on March 18, 2019

Hong Leong Industries Bhd
(March 15, RM10.10)
Maintain hold with a target price (TP) of RM10.21: After plunging to a two-year low last December following its removal from the syariah-compliant list, Hong Leong Industries’ (HLI) share price has been recovering steadily on expectations that financial year 2019 (FY19) earnings would register double-digit growth despite 1HFY19 core net profit dropping marginally by 4% year-on-year (y-o-y).

We expect HLI to achieve y-o-y core net profit growth of 12.5% in FY19, underpinned by higher contribution from the consumer segment amid improved sales from Yamaha Malaysia and various cost rationalisation efforts at its duopoly ceramic tiles division (50% market share). However, these would partly be offset by a competitive operating landscape in Vietnam and dwindling demand at its industrial product division.

Yamaha Malaysia, a subsidiary of HLI that holds the official franchise for Yamaha motorcycles, is still the major earnings contributor to the company, accounting for 65% of FY18 core net profit. With Yamaha commanding a leading motorcycle market share of over 40% in Malaysia (followed by Honda’s 25% share), we expect Yamaha Malaysia to continue to be HLI’s main earnings driver going forward, contributing over 70% of HLI’s earnings in FY19-21.

Our assumptions of 10-11% y-o-y motorcycle revenue growth in FY19-21 are on the back of higher total industry volume (TIV) forecast of 550,000 units in FY19 (FY18: 496,000 units). The TIV growth would come on the back of various government initiatives, primarily:

(a) replacement of goods and services tax with sales and service tax, which is only applicable for motorcycles above 250 cylinder capacity (cc);

(b) introduction of various finance schemes; and,

(c) granting of petrol subsidies for motorcycles below 125cc.

Separately, management’s pivotal strategy to focus on higher cc motorcycle sales is also expected to drive revenue growth. The management concurs that the group is focusing on increasing the sales of 150cc motorcycles, which currently account for 35% of total sales volume and have grown 70-80% y-o-y in FY18.

Note that the 150cc motorcycles command a higher margin than the 125-135cc which form the largest share of total revenue currently.

We remain upbeat on HLI’s duopoly tiles division as it has achieved significant yield improvement over the years amid ongoing internal rationalisation efforts such as streamlining of a number of workers and reducing its stock keeping unit.

This is despite declining average selling price; higher competition from increased imports of China products; and, higher gas tariff.

With the utilisation rate of 80-90%, the company is focusing on growing its retail sales, which command higher margins, to grow the bottom line.

Ceramic tiles sales made up around 20% of FY18 total sales and this share is expected to remain relatively stable in FY19-21.

Meanwhile, the management expects the industrial products segment — fibre cement and concrete roofing tiles — to remain challenging owing to foreign worker issues, and rising raw materials and utility costs. We forecast this segment to remain in the red for the next three years amid structural issues.

HLI’s 24%-owned Yamaha Vietnam has a local market share of over 20%, trailing Honda the market leader which commands over 70%. Over the years, Yamaha Vietnam sees a continuous challenge in gaining market share in the fast developing and competitive Vietnam market where competitors would offer attractive rebates to entice customers. While Vietnam’s economic growth is robust with a growing young population, we remain conservative on the outlook for Yamaha Vietnam and have factored in a 5% annual contraction in sales in FY19-21.

Steady revenue growth and cost rationalisation have allowed HLI to generate robust operating cash flow of RM331 million-RM478 million over the past three years. Coupled with little capital expenditure, net cash has been growing significantly and we believe its strong free cash flow would sustain a consistent dividend payout.

While there is no dividend policy, HLI had distributed 50-53% of its earnings over the past three years. We expect it to distribute at least 50% of its earnings, implying a 2020F dividend yield of 5.6%.

Therefore, we cut our net profit forecasts by 4.7% and 6.4% for FY19 and FY20 respectively. We also introduce the FY21 forecast. — UOB Kay Hian, March 15