Automotive (NEGATIVE) - The perfect storm

Good morning,

We have published our 2H16 strategy for Malaysia today. Following are the snippets for the Automotive and Semiconductor sectors.

Automotive (NEGATIVE) - The perfect storm

• A disastrous 1H16. Weak consumer sentiment and higher car prices (adjusted for the weak MYR by auto players) at beginning 2016 hampered car sales with TIV hitting 218k units in 5M16 (-18% YoY), at just 35% of our 2016 TIV forecast of 620k units (-7% YoY). This fall is by far the largest in the last decade compared to the last double-digit contraction of 11% in 2006. In terms of market share for 5M16, the pie has shifted from Proton (-2.3ppts) and Toyota (-1.9ppts) to the rest of the major marques.
• 2H16 outlook. We cut our 2016 TIV forecast to a street-low 590k units (-12% YoY) with expectations that sales in the remaining seven months of 2016 would average 53k units on the back of new launches and aggressive sales campaign. Forward monthly TIV will need to hit an average of 57.4k units (vs. 2015/5M16 monthly average: 55.6k/43.6k units) to meet our earlier 2016 TIV forecast of 620k units which is no longer realistic. Softer TIV amid a volatile MYR against the USD and JPY are key factors that blight the auto players’ economies of scale and profitability in 2016. The reported 1Q16 auto sector earnings (-94% YoY, -90% QoQ) was a case in point. Meanwhile, 2Q16 earnings are unlikely to see any major improvement.
• Stock picks. We are NEGATIVE on the sector with key SELLs on UMWH and TCM for their negative USD-cost exposure amid softer demand at their auto business (i.e. 5M16 Toyota/Nissan car sales: -31%/-14% YoY). Furthermore, UMWH also suffer sustained losses in its O&G division while TCM continues to bleed in its Indo-China operations.

We remain selective on our picks and favor Pecca (BUY) for its (i) growth potential riding on rising adoption of leather upholstery and (ii) exposure to Perodua which is set to unveil the highly anticipated sedan model in 3Q16. Elsewhere, we like BAuto (BUY) for its (i) growth potential in both Malaysia and the Philippines and (ii) value unlocking via potential IPO of its Philippines operation. However, we do caution that near-term earnings could take a hit from high JPY-denominated costs on imported cars/components. MBM remains a HOLD; re-rating would likely come from better-than-expected performance by 22.6%-associate Perodua.

Elsewhere, we note Cycle & Carriage Bintang’s (CNCB MK, Not Rated) exposure to the thriving premium car segment via Mercedes Benz (5M16 sales: +21% YoY) being Mercedes Benz’s biggest dealer in Malaysia. CNCB’s 1Q16 earnings jumped 43% YoY. We also observe that CNCB has a history of paying out hefty dividends once its retained earnings hit the MYR100m level (i.e. MYR2.03/1.35/1.20 dividends in 3Q06/3Q08/3Q09). Jardine Cycle & Carriage owns 59% of CNCB. From a valuation perspective, we would like to point out DRB-Hicom (DRB MK, Not Rated) which is currently trading near trough valuation on a prospective consensus FY3/16 book value at just 0.3x.

Semiconductor (POSITIVE) - The tide has turn

• 1QCY16 semiconductor earnings were hit by a double-whammy: (i) weak demand due to channel inventory rationalization by a major smartphone player and (ii) unrealized forex losses from mark-to-market of cash and receivables at USD1/MYR3.90 as at end-1Q16. As a result, most technology counters saw a double-digit decline in share price YTD.

• Worth a second look. We expect sentiment on semiconductor & equipment players to improve in 2H16 with demand picking up from May/June 2016 onwards in anticipation of a major smartphone launch in Sep 2016. Furthermore, with USD/MYR forex reversing to the 4.03-level at end-June from 3.90 at end-Mar, we expect some reversal of the unrealized forex losses in 2QCY16 earning. Alongside a potential cut in the OPR which could further weaken the MYR, this provides trading opportunities for the export-orientated semiconductor stocks.
• Stock picks. Our Top BUY pick is ViTrox for its improved earnings visibility and new ventures into wafer-level/non-tech inspection. The strong momentum from 1Q16 would likely sustain on substantial order backlog, with strong demand from both new and existing semiconductor players in Taiwan and China for the production of Chinese smart devices. Book-to-bill ratio stays on an uptrend, showing signs of a healthy order replenishment.

Elsewhere, we also like with Inari for its growth outlook, riding on (i) increasing RF content in future smart devices and (ii) Broadcom group of companies’ continuous effort to outsource their manufacturing processes. Coupled with contribution from its new ventures (i.e. fiber-optics chip fabrication division for CyOptics, Broadcom), Inari should be back on a strong growth trajectory in FY6/17. Both ViTrox and Inari are (i) beneficiaries of a weaker MYR against USD, (ii) in good net cash position, (iii) Shariah-compliant. Globetronics remains a HOLD for uncertainty in orders for its sensor division.