We recently met the management of UMW. We remain upbeat on the stock as prospects continue to be promising for the company’s auto division, with sales numbers growing at an encouraging 14%. Moving forward, we also see UMW becoming a major upstream oil and gas (O&G) player, hand in hand with Petronas as a key partner in the development of marginal oil fields. We are upgrading our conservative margin assumptions for UMW, hence nudging up our earnings forecast for FY12/FY13/FY14 by 14%/13%/9% respectively. Our new FV stands at RM12.07 and with its 4.6% dividend yield, this gives a total upside of 28%. Maintain high conviction buy and top pick in the auto sector.
Outlook for auto remains promising. We recently met the management of UMW, who remains upbeat on the outlook of the company. There are indications that vehicle sales target will see a 3.2% upward revision from 93,000 units to 96,000 units, though we think this is still a conservative target as we expect sales to touch 101,056 units for FY12. In addition to its growing market share in new car sales over the recent years UMW has also seen higher revenue contribution from after sales and used car businesses. Furthermore, recent numbers from Malaysian Automotive Association shows that sales of the Vios and the Camry have remained encouraging despite Honda’s comeback. Over the medium to longer term, model launches will continue to be driven by face lifts and a big boost to volume could potentially be Toyota’s upcoming eco car.
Growing its oil and gas business. In late June, UMW and Petronas signed a MOU to set up a training academy that will help address the shortage of skilled Malaysian personnel in the O&G and drilling industry. We see this as a move forward in forging a long term partnership with Petronas for UMW as its major offshore drilling contractor. The lack of domestic players in the O&G drilling field bodes well for local players such as UMW, which expect to be a major beneficiary in the developments of marginal oil fields where its Jack-up drilling rigs specs are best suitable for.
Earnings upgraded. We expect UMW to post higher earnings boosted by its auto division as q-o-q and y-o-y vehicle sales had jumped by 30.1% and 40.1% respectively. We have been very conservative in our margin assumptions for the auto and O&G divisions, which we are now revising upwards to 16% and 18% respectively from 14% and 17% previously. All in, this upgrades our earnings forecasts for FY12/FY13/FY14 respectively by 14%/13%/9%. Our new FV stands at RM12.07 and with its 4.6% dividend yield, this gives a total upside of 28%. Maintain high conviction buy and top pick in the auto sector.
KEY HIGHLIGHTS
Revising up sales target. We recently met the management of UMW which remains upbeat on the outlook of the company. Indications are that there will be an upward revision in vehicle sales target from 93,000 units to 96,000 units, up by 3.2%. The new target is still conservative in our view as we estimate that Toyota sales could touch 101,056 units in 2012, up 14% y-o-y. For 2013, management will continue to bring in new face-lifted models which will see auto sales for the year for Toyota sustaining well to record a growth of 8.3% y-o-y. Moreover, its growing market share over the recent years has also resulted in UMW seeing higher revenue contribution from its after sales and used car businesses.
Honda’s come back a threat? Many have argued that UMW benefited strongly from the absence of competition from Honda, which had halted production for several months. While we concur, the recent numbers from Malaysian Automotive Association shows that sales of the Vios and the Camry has remained encouraging despite Honda making a comeback. UMW’s localized Camry bookings continue to be encouraging, standing at 3,000 units with a two-month waiting period.
Eco car a big wild card. A wild card that could see Toyota sales propelling further is the possible introduction of its Eco car into its lineup after its launch in Thailand slated in 2013. Note that Toyota is the only major eco car maker that has yet to launch a vehicle globally. We think Toyota is holding back for now pending the introduction of new policies by the Indonesian and Malaysian governments.
What the upcoming NAP will unveil? We think the upcoming National Automotive Policy (NAP) could likely be unveiled before year-end. We understand that most of the framework for 2012 has already been finalized. The upcoming NAP will focus on promoting green technology and a greener holistic system, from production to processes to supply chain. This means, it would not only confine to just hybrids, but also conventional internal combustion engines that meet multi-tiered fuel economy and exhaust emission targets. Our checks also reveal that there could be a revamp in fuel pricing policy, which would spur sales of fuel efficient vehicles. While many automakers are banking on the End of Life vehicle scrapping policy, this will not be introduced anytime soon until the industry as a whole, across all supply chains, has been completely reformed. To further liberalize the auto sector, the upcoming NAP is expected to lift the freeze on manufacturing licenses for new applicants keen in manufacturing models below 1.8-litre or RM150,000, provided that they meet the Enhanced Environmentally friendly Vehicle (EEV) standards, which is based on certain fuel economy standards. While this opens up competition, we reckon only a selected few will meet the EEV standards.
Long term commitment to Petronas. In late June, UMW signed a MOU with Petronas to set up a training academy that will help address the shortage of skilled Malaysian personnel in the O&G and drilling industry. We see this as a step forward in forging a long term partnership with Petronas as the latter’s major offshore drilling contractor. Currently, of all its three existing rigs, two are chartered out to Petronas. Our latest checks reveals that Petronas currently operates 14 rigs (13 in South East Asia and one in the Caspian Sea), of which two are owned by UMW (Naga 1 and Naga 3) and one belongs to SapuraKencana. The lack of domestic players in O&G drilling field bodes well for local players such as UMW, which we see as a major beneficiary in the development of marginal oil fields where Jack-up drilling rigs specs are best suitable for. Rig utilization in South East Asia is currently at 80% compared to 72% last year. As for Jack-up rigs specifically, utilization has been hovering at around 78% over the past three years globally and hence, we think rates would not be too highly priced.
+1 purchase option of drilling rig likely to be exercised. We see the likelihood of UMW exercising its +1 option for the purchase of an additional Jack-up rig for RM212m following its recent purchase of the Naga 4. The Naga 4 will be delivered by Feb 2013 and the +1 option, if exercised, will be delivered by July 2013. We understand that Petronas has three Jack-ups contracts with Rowan and Aban Offshore that will expire by end 2012 and this gives UMW a higher chance to rake in new contracts for its new drilling rigs. Even if there is a need for Petronas to use its rigs it could be under short term basis as they may prefer to lock in charters with UMW given that their rigs are brand new and could be used as a training field for their drilling academy.
Rights issue on the cards? There are concerns that UMW’s debt rating, currently at AAA, will be compromised given the high capex allocated over the next two years for the acquisition of its drilling rigs (if +1 option is exercised). UMW so far is allocating a capex totaling RM200m for the Camry localization and with the purchase of the two Jack-ups, capex over the next two years could average at RM800m per annum, 50% more than its RM520m average per annum over the past three years. However, with the higher income generated from the drilling assets, we foresee that this will improve the company’s interest coverage ratio, which we expect to rise to 31x by FY13 from 17.8x currently. Hence, we see no immediate concern of UMW doing a rights issue exercise as it has ample room to gear up its debt further. As of 1QFY12, UMW is sitting on a net debt pile of RM312m (net gearing of 7%) but we expect this to reverse to net cash as the sales of more inventories come 2H will improve its overall cash conversion cycle. UMW tends to be in net debt position during the 1H of the year due to inventory buildup and capex allocation. We expect the company to remain at net cash levels generating free cash flow in excess of RM1bn per annum. This proves favorable for investors on the likelihood of UMW dishing out higher dividends. We are still expecting a conservative payout ratio of 50%, giving a dividend of 44.4sen for 2012 to yield at an attractive 4.6%.
O&G division restructuring updates. UMW is currently undergoing a restructuring exercise to streamline its O&G operations. Management has recently disposed of its fabrication business in Vietnam, and this will see further asset disposal of its non-core businesses such as trading of O&G equipments where margins are thin. As for its pipe manufacturing business, notably for its associate WSP, prospects continue to be challenging although it is seeing its businesses expanding to other regions, notably to South America, Middle East and Central Asia, improving its total volume by 2.5% y-o-y. The decision on whether to take up the privatization offer for WSP Holdings will be decided by end 2012. We believe UMW will likely be better off taking up the offer given that it has already recouped its investment costs totaling close to RM300m through dividends and profit contributions. Should the privatization offer for WSP be exercised, UMW will rake in a total cash of USD13.6m at an offer price of USD3/share. Noting that the share price is still at USD1.7/share, there could potentially be a reduction in the offer price. As UMW does not own a majority stake in its pipe manufacturing businesses, its core focus will be on the upstream drilling segment and moving forward, we could be seeing more aggressive rig acquisition as the development of the marginal oil field progresses. Upon the completion of the restructuring exercise of its O&G division, we see the much awaited listing coming in eventually, sometime in 2013-2014. As its O&G division has been in losses over the past few years, valuations from this division have yet to be priced in; hence, we are essentially valuing it for free.
Earnings upgraded. We expect UMW to post higher earnings q-o-q and y-o-y boosted by its auto division as q-o-q and y-o-y vehicle sales jumped by 30.1% and 40.1% respectively. Despite the calamities of events last year, UMW’s margins continued to inch higher on the EBITDA level, its highest since 2009 (FY09: 9%, FY10: 13%, FY11: 15%) and we expect margins this year to inch to record levels, thanks to the weak USD against the RM. Furthermore, this will also bode well for its equipment division too given that its costs are also in USD. In anticipation of the strengthening RM coupled by the economies of scale from the higher volume; we anticipate that auto earnings will grow by 24% y-o-y. We have been very conservative in our margin assumptions for the auto division, of which we have revised up from 14% to 16%. We have also slightly nudged up our oil and gas EBITDA margin assumptions to 18% from 17%, in line with the margins it had earned the previous year. All in, this upgrades our earnings for FY12/FY13/FY14 by 14%/13%/9% respectively. Our earnings estimates of RM1bn and RM1.17bn respectively for FY12 and FY13 (earnings growth for FY12 of 23% and FY13 of 13%) are higher compared to consensus’ RM858m and RM932m. We believe this is growth number is achievable, noting that back in 2010, UMW’s earnings grew strongly at 38% y-o-y after recording vehicle sales growth of 12%, driven by 82% jump in earnings from Toyota.
Foreign interest picks up. UMW’s earnings potential upside, coupled with its attractive dividend yield has generated a lot of foreign interest. Foreign shareholdings have increased from 15% in 1Q FY12 to 22% currently. Its three months average trading volume for the stock has also spiked up 82%.
Maintain BUY at a higher fair value. In anticipation of earnings visibility coming from the O&G division, we peg UMW’s O&G business at a higher multiple of 14x from 12x earlier. We see room for further upside for the stock, as our revised FV of RM12.07 plus its net dividend yield of 4.6% give a collective upside of over 28%. Our new FV implies a PE multiple of 12x, which is still below its mean of 13x since 2008. We maintain high conviction buy and top pick in the auto sector. Since we upgraded the stock back in February 2012, it has gained 40% to become the FBMKLCI’s best performing stock, outperforming by the KLCI by 33%.
Source: OSK
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