Update: UMW Holdings (UMWH MK; HOLD; TP: MYR9.50) - Sets foot in aerospace engineering

UMW Holdings (UMWH MK; HOLD; TP: MYR9.50) - Sets foot in aerospace engineering

• No positive near-term earnings impact. Wholly-owned UMW M&E and UMW Aerospace, have signed a 25+5 year agreement with Rolls-Royce Plc (top 3 global aircraft engine manufacturer alongside General Electric and Pratt & Whitney) to manufacture and assemble fan cases for the upper range aero engines, Trent 1000 (estimated to cost USD25m-30m per engine). The fan case, one of the largest parts of the engine, consists of approximately 4k components.

UMWH expects to commence production domestically in 4Q17 with the project cost estimated at ~MYR830m as reported by the press.

• Stay sideline.  We are neutral on this development as there will be no positive earnings impact to UMWH in the near term. Further clarification is required from management on:

                     I.        UMWH's competitive edge which garnered this win despite having no prior experience in aerospace engineering.

                    II.        Addressable market size of this business and its expected returns and payback period.

                   III.        Funding structure of this ~MYR830m project.

Positively, this expansion may serve to further diversify UMWH's automotive-centric earnings base and reposition UMWH's core competencies in new technologies. What is required of UMWH is a clearer strategy with regards to its non-core division which has seen back-to-back losses over the past three years.

With no major catalyst in sight, we expect 2Q15 (due out on 26^th Aug 2015) earnings to remain lacklustre as (i) weak Toyota vehicle sales overshadows Perodua’s growth, (ii) the stronger USD continues to weigh on UMWH’s imported component cost and (iii) lower DCRs and utilisation of UMWOG’s JUs would dampen O&G earnings.