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DRB-HICOM BERHAD: Potential New MYR 3-Year Bond at 6% What's Happening? Based on the Information We Have Received from Bond Un

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DRB-HICOM BERHAD: Potential New MYR 3-Year Bond at 6% What's Happening? Based on the Information We Have Received from Bond Un DRB-HICOM BERHAD: Potential New MYR 3-Year Bond at 6% Figure 1 Wisma DRB-HICOM in Shah Alam Image Credit: The Edge Markets What’s happening? Based on the information we have received from bond underwriters, we are expecting DRB-HICOM Berhad (DRB) to issue a new MYR three-year Islamic medium-term notes with pricing in the 6% area. Similar to the outstanding DRB-Hicom bonds, the new issue is expected to be ranked 1st lien with financial service reserve account and rated A+IS by the Malaysian Rating Corporation Berhad (MARC), which is the same issuer rating of DRB. We were informed that the proceeds of the new issue are for general corporate purposes, working capital requirements, refinancing of any existing debt borrowings or future financing of the company. In this article, we give an introduction to the company and provide our comments on the new bond. About DRB-HICOM Berhad DRB (the Group) is an investment holdings company that operates across several segments: automobile, services (waste management, vehicles inspection, banking, logistics and component manufacturing), and property, asset & construction. The Group has several prominent brand names under its table (see Table 1). DRB is listed on Bursa Malaysia with a market capitalisation of RM 4.30 billion (as of 3 May 2018). DRB derives most of its revenue from its automotive segment (Chart 1). The Group manufactures and distributes the national car brand of Malaysia, Proton via its 50.1% stake in PROTON Holdings Berhad (Proton). The Group also hold significant stakes in companies assembling and distributing Honda, Isuzu, and Mitsubishi in Malaysia. Table 1: List of DRB’s prominent subsidiaries and associates No Company Effective Business Description Interest 1 PROTON Holdings Berhad 50.10%* Malaysian national car manufacturing 2 Pos Malaysia Berhad 53.50% National postal services provider 3 Bank Muamalat Malaysia Berhad 70% Full-fledged islamic financial institution licensed by Bank Negara Malaysia 4 Honda Malaysia Sdn. Bhd. 34% Markets and distributes Honda vehicles in Malaysia 5 Isuzu Malaysia Sdn. Bhd 48.42% Markets and distributes Isuzu vehicles in Malaysia 6 Mitsubishi Motors Malaysia Sdn. Bhd. 48% Distribute Mitsubishi Motors vehicles in Malaysia exclusively 7 Motosikal dan Enjin Nasional Sdn. Bhd 81% Malaysia’s homegrown motorcycle brand manufacturing 8 Alam Flora Sdn. Bhd. 97.37% Solid waste and public cleansing services Source: The Group’s filings and annual report 2017, iFAST compilations. Data as of 31 March 2017 *Data as of 2 May 2018 Chart 1: Automobile segment contributes most of the company’s earnings Automobile Services Property, Asset & Construction 3.5% 29.5% 67.0% Source: Bloomberg, iFAST compilations. Data as of 31 March 2017 Strong Ownership Structure Tan Sri Syed Mokhtar Shah bin Syed Nor Al-Bukhary, the 12th richest man in Malaysia (Forbes, 3 May 2018) owns a major stake of 55.92% in DRB-HICOM via Etika Strategi Sdn Bhd. On top of that, Malaysian government entities Employees Provident Fund Board (EPF), Lembaga Tabung Haji and Kumpulan Wang Persaraan (KWAP) collectively control 19.65% of the outstanding shares as of 30 April 2018. Leading the management team are Dato' Mohammad Zainal Shaari (Group Chairman), who was the former executive director and chief operating officer of Khazanah Nasional Berhad, and Yang Bahagia Dato' Sri Syed Faisal Albar bin Syed A.R. Albar (Group Managing Director). Yang Bahagia Dato' Sri Syed Faisal served as Chief Executive Officer (CEO) of Malakoff Corporation Berhad and Gas Malaysia Berhad prior to joining DRB. Financial Assistance from Government; Zhejiang Geely - New Strategic Partner Despite the weak financial performance of PROTON Holdings in the past, the government has demonstrated its strong support towards Proton by giving a variety of government assistance including waiver of taxes. The former International Trade and Industry Minister Datuk Seri Mustapa Mohamed said in April 2016 that the Malaysian government had extended financial assistance totalling RM 13.9 billion since Proton’s inception in 1983. In the most recent instance of government financial aid (June 2017), Proton obtained a RM 1.25 billion soft loan from the government to clear its dues to vendors. As a condition stipulated by the Malaysian government to provide the monetary support, Proton was committed to engage with a foreign strategic partner, which is to help Proton achieve sustainable growth by enhancing its technology, productivity, sales and customer confidence. Subsequently in May last year, Proton announced a strategic partnership with Zhejiang Geely Holdings Corporation limited (Geely), China’s leading automotive manufacturer. Under the share subscription agreement, Geely acquired in September 49.9% equity interest in Proton for a total subscription price of RM 460.3 million. The subscription price was satisfied in cash (RM 170.3 million) and the grant of the license of Geely’s Boyue model (Figure 2) (at an ascribed value of RM 290 million). Figure 2 Geely's Boyue. Image Credit: Youtube Channel (Auto Video) Expect to turnaround with its new partnership Proton and Geely are planning to launch their first-ever Sport Utility Vehicle (SUV) model under the Boyue brand by Q4 this year. The Honda HRV (starting price at RM 98,060; 1,799 cc) and Mazda CX3 (starting price at RM 131,159.30; 1,998 cc) have been thriving in the compact SUV segment. We believe Proton would be able to carve a meaningful market share from this segment with its long- standing cost advantage; foreign manufactured cars are prohibitively expensive in Malaysia due to import duties. The current car model line-up of Proton entails a total vacuum in the SUV segment. The upcoming launching of the Boyue SUV is expected to boost the falling market share of Proton (Chart 2). Chart 2: Proton’s tumbling market share Market Share of Proton in Malaysia (%) 30 26.4 25 22.5 21.2 20 17.4 15.3 15 12.5 12.3 10 5 0 2010 2011 2012 2013 2014 2015 2016 2017 Source: Bloomberg, iFAST compilations. Data as of 31 Dec 2017 Apart from the new model initiative, the new CEO of Proton, Dr Li Chunrong has also given an ultimatum to Proton’s automotive spare parts suppliers to cut prices by 30% by year end. It is commonly perceived that Proton’s vendors have been charging the company uncompetitive prices in the past. Bringing supply costs down to market levels should reduce Proton’s operating cost, which may enable the company to cut its already affordable prices even more. Thus, we believe the efforts described above will likely lead to a successful reform of Proton. Having secured a global automobile manufacturer as its strategic partner, we expect Proton to turn its fortune around in the near-term. Comfortable Gearing; Low Refinancing Risk The Group posted an improved gearing ratio (net debt to equity) of 9.92% in 31 December 2017, down from 18.26% in 30 June 2017. We note that its gearing ratio has fallen in recent quarters (from the peak of 43.05% in June 2016, mainly due to the RM 1.25 billion government soft loan (via redeemable convertible cumulative preference shares that are accounted as equity). As of 31 December 2017, the Group reported a sizeable cash and cash equivalents of RM4.105 billion, which it could use to meet its refinancing needs, considering 38.05% of its borrowings (about RM2.31b) is repayable within a year. Beyond 2018, DRB’s refinancing risk is manageable, as the debt maturity (Chart 3) is distributed rather evenly. Chart 3: Debt Maturity Profile of DRB 1,900 1,810.00 1,700 1,505.09 1,500 1,271.30 1,300 1,100 900 RM' Million 700 500 415.00 250.00 300 100 2018 2019 2020 2021 2020 and thereafter Year Source: Bloomberg, iFAST compilations. Data as of 3 May 2018 Overall, we think DRB’s near-term refinancing risk is mitigated by its established position in the domestic automobile industry (stakes in Proton and Honda Malaysia), potential fund-raising channel through equity initial public offering for its prominent unlisted entities (Bank Muamalat Malaysia Berhad and Alam Flora Sdn. Bhd), sizeable asset base (total assets of RM 42.8 billion), and well- staggered debt maturity profile. Valuation The expected pricing of 6% represents a spread of 240 basis points over the three-year Malaysian Government Investment Issue (MGII) benchmark (as of 8 May 2018). In this case, we see the existing MYR bond of another automobile player (UMW Holdings Berhad), UMWHMK 4.700% 04Oct2021 as the closest comparable. The UMWHMK 4.700% 04Oct2021 is currently trading at yield to maturity (YTM) of 4.53%. As a comparison, UMWHMK 4.700% 04Oct2021 comes with slightly longer tenor of about 3.42 years and lower seniority ranking (senior unsecured) despite having lower YTM. The lower yield is reasonable as UMW Holdings Berhad has a lower gearing (net debt-to-equity ratio of 7.25% as of 31 Dec 2017) and a significantly larger market capitalisation of RM 7.16 billion (as of 3 May 2018). Looking at DRB’s issuances, the closest comparable is DRBHMK 6.30% 05Nov2020. Based on the expected 6% pricing, the new DRB bond indicates a yield pickup of 30 basis points over the DRBHMK 6.3% 05Nov2020, which currently offers a yield to maturity of 5.70% based on its indicative ask price of 101.35. As such, we see the new issue as a bargain relative to DRB’s existing issues due to the yield pickup. Considering the strong government support to DRB in the past and a potential turnaround story, we view the new issuance as a compelling high yield opportunity for a three-year tenor on the basis of the above-mentioned credit positives.
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