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Marc Djandji, CFA is the Editor-in-Chief of The ASEAN Insider, a subscription-based monthly investment newsletter committed to finding compelling investments backed by powerful structural trends in Southeast Asia. He is also a co-Founder and Partner of ASEAN Strategy Group Ltd., an independent... More
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  • DRB-HICOM: Synergies Poised To Kick-In 0 comments
    Apr 3, 2013 6:37 AM

    By Marc Djandji, CFA

    The Malaysian economy proved resilient to the global recession and has witnessed strong growth in the last couple of years. For 2013, it's expected to again witness a growth rate of ~5% driven largely by strong domestic demand.

    DRB-Hicom (1619.KL) has several catalysts in place to propel it to further growth while providing diversification and reach into various growing sectors of the economy. Best of all, valuations are attractive for a growing conglomerate. At RM2.55, the shares trade at ~18x FY13E consensus EPS of RM0.141, ~10x FY14E consensus EPS of RM0.253, and P/B of 0.7x, which is compelling given the company's long term growth potential. The investment rationale for buying the stock is as follows:

    1. Recent acquisition of Proton and CRTM to boost automotive segment growth:

    Automotive segment with 9M13 reported revenue of RM7.5bn (+188.5%, due to first time Proton consolidation) is the largest of the three business segments with top line contribution of c.77% (9M13). Proton acquisition gave DRB-Hicom a manufacturing and technology platform to become an integrated automotive player in the region and thus to tap future growth opportunities in the automotive sector. Proton's acquisition is currently under a restructuring plan and is expected to become the company's main growth driver. .

    Proton turnaround is focused on rationalizing its supply chain which should help in quality and cost control besides enhancing operational efficiency. Further, the Proton Edgar and EON merger should rationalize distribution network and provide business and cost synergies. New model launches such as Preve Hatchback, Global Small Car, and strategy of penetrating overseas market including Thailand, Indonesia and Australia should further boost growth.

    Proton's presence throughout the industry value chain makes it a preferred local partner for global automotive leaders looking to enter the Malaysian market. For a successful turnaround of Proton, the group needs partners, technology and platforms to exploit its capacity. It's collaboration agreements with Honda, Mercedes Benz, Mitsubishi, Volkswagen AG (VWAG), Suzuki, Isuzu, and Audi offer opportunities to reorganise component manufacturing to upscale its offerings and capacity.

    Recently, Honda committed capex of RM1bn to be incurred in the next 3 years to make Malaysia its regional manufacturing hub for its hybrid vehicles, Insight and Jazz. Honda is expected to expand its Pegoh plant to double its capacity to 100k units per year. Proton should benefit from Honda's capex commitment. Further, Proton should also benefit from VWAG's plan of ramping up capacity to 50k units' p.a. to fulfil its regional production hub plan and meet ASEAN exports needs by 2017/2018.

    The Automotive division should get further boost with CRTM acquisition by DRB's defence unit (Deftech). DRB expects CRTM to be a key support in the design and production of composite frames for its AV8 armored vehicle contracts, and to extend opportunities in aerospace. Management indicated CRTM acquisition to be earning accretive and with the recent award of RM7.55bn contract for supplying of AV8 armored vehicles we are positive on the acquisition.

    As of March 2013, the company signed an MoU with Saab AB to combine competencies and capabilities to provide cost-effective solutions to support the Malaysian government's defence programme. Together, both companies will explore design and manufacture of advanced composite systems and components for military and commercial aerospace applications, composite repair technology, and system integration of electronic warfare, avionics and other airborne systems.

    2. POS acquisition and KLAS prospects to boost service segment growth:

    The service segment is the second largest contributor to the top line with 20% contribution. Where DRB's of solid waste management business provides it with stable and visible revenue we expect most of growth for this segment to come from its Banking, Insurance, and Airport services. Its banking, insurance and airport services should get support from POS Malaysia acquisition which should provide them the much needed network/ coverage to extend their penetration.

    Synergizing both POS Malaysia and Bank Muamalat, DRB set up to offer a sharia-based Islamic Pawnbroking service, ArRahnu@POS. The first phase roll-out is expected to see at least 50 outlets offering ArRahnu@POS service by the end of FY2013. Through POS Malaysia, DRB, established a strategic partnership with Uni.Asia Group for the distribution of vehicle insurance through more than 700 postal outlets nationwide and the introduction of POS Hayat insurance, an affordable life insurance for the public. With the POS acquisition, opportunities remain abundant to tap into its network in extending insurance, logistics and supply chain services among others.

    DRB's airport service subsidiary KL Airport Services (KLAS) should also benefit from POS Malaysia. Synergies can be worked out in the areas of integrated supply chain and logistics services. Although at present KLAS top and bottom line contribution is only about 2% of total revenue, this service holds excellent growth opportunities. KLAS is one of the only two licensed ground handling service providers (the other bigger player is MAS) and controls 57.4% market share of foreign airlines at Kuala Lumpur International Airport. KLAS is expected to continue its strong growth from 1) Commencement of KLIA2 - should bring opportunities from LCC (Low Cost Carriers) such as Malindo Airways and Spice Jet, 2) Integrated logistics (value supply chain), and 3) Expansion of stations capability and potential new airlines. Turkish Airlines is recent new customer and KLAS is also bidding for Air France and Philippines Airlines.

    3. Unlocking of property value and new launches to boost PAC growth:

    Property, Asset and Construction (NYSE:PAC) business segment contributes to 3% to the group's top line. The company's owns land in strategic locations, including over 600ha in the southern economic growth corridor of Iskandar Malaysia (Iskandar) in Johor.

    With planned RM11 billion property projects in next 36 months, we expect the conglomerate to be among the larger players in the property market. Among projects being planned include the Jalan Tun Razak development, which will feature a mix of offices, and service and hotel apartments, second phase of Laman Glenmarie II; luxury Garden Villas in Glenmarie; and a mixed township project in Johor called Glenmarie Heights. DRB plans to introduce signature commercial developments to include Glenmarie Wahyu (Kuala Lumpur), and HICOM Pegoh Park (Melaka). We expect residential and commercial development of Proton City should catalyze new growth in the region.

    4. Improving Financial Position:

    As per 9M13 results (latest reported results), DRB-Hicom has a net debt of RM3.2bn. As per annual report 2012, DRB was to pare down at least RM1bn worth of debt by mid-2013. DRB expected to do this with selling of non-core assets. It recently sold DRB-Hicom Power (power subsidiary) for RM575m. It's expected to pare down its Bank Muamalat stake from 70% to 40% as per Bank Negara's regulations. We believe this should further reduce the gap of RM1bn. We do not overrule possibility of selling part or full stake in its insurance arm Uni Asia.

    With the payment of RM1 billion debt, group's financial position should improve. We should see higher internal cash flow generation once Proton's turnaround is complete and its margins return to positive territory.

    Further with recent high value acquisition (Proton - c.RM3bn) and enough on plate (Proton turnaround, POS Malaysia integration etc), we don't expect any major organic or inorganic capex in near term except for implementation of current plans.

    5. Attractive Valuation:

    The current valuation doesn't reflect the group's true earning and growth potential. At RM2.55 the stock trades at a compelling ~18x FY13E consensus EPS of RM0.141, ~10x FY14E consensus EPS of RM0.253, and P/B of 0.7x, which is compelling given the company's growth from the restructuring of its automotive division, its hidden value in real estate and synergies from POS Malaysia.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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