HIVING off its oil and gas division is just the first step in the group’s growth strategy to return to profitability. President and group CEO Badrul Feisal Abdul Rahim hopes to start with a clean slate but the path to recovery may not be plain sailing, say analysts.
It has not been an easy 16 months for Badrul Feisal Abdul Rahim since he took over as UMW Holdings Bhd’s president and group CEO on Oct 1, 2015.
Just months into his tenure, he had the dubious honour of presenting the group’s worst full-year financial results since 1998.
For the financial year ended Dec 31, 2015 (FY2015), UMW posted a net loss of RM37.2 million on revenue of RM14.44 billion as lower income from its automotive division was exacerbated by widening losses in its oil and gas (O&G) operations.
It was UMW’s first full-year loss in 17 years, and the night got darker in FY2016, his first full year as CEO, Badrul tells The Edge. UMW is set to release its FY2016 numbers on Feb 27.
“Yes, 2016 is going to be a bad year. We are expecting losses and I think we will see a new low [compared with 2015],” he says, adding though that he sees dawn ahead. “The most important thing is that we are on the right track to recovery from 2017 onwards.”
For the nine-month period up to Sept 30, 2016, UMW posted a revenue of RM7.9 billion, down 22.9% from the previous corresponding period. Its cumulative net loss stood at RM322.2 million compared with a net profit of RM930.7 million the year before.
Disposing of its listed O&G arm, UMW Oil & Gas Bhd (UMWOG), is the first step in the group’s road to recovery as it refocuses on its remaining three core divisions — automotive, equipment, and manufacturing and engineering.
On Jan 19, UMW announced that it would exit UMWOG, passing on its 55.72% stake to its shareholders via a distribution-in-specie pending their approval via an extraordinary general meeting to be held at end-March or in early April.
For perspective, had it not been for the combined pre-tax loss of RM834.5 million from its O&G operation in FY2015, UMW’s pre-tax income would have been roughly RM1.1 billion.
This may explain the market’s enthusiastic response to the news of the disposal. On Jan 20, the day after the announcement, UMW’s shares surged 9.96% to end at RM5.08. It was the stock’s biggest single-day gain since August 1999.
To recap, the divestment is part of a consolidation exercise that centres on UMWOG. Also on Jan 20, UMWOG and Ekuiti Nasional Bhd (Ekuinas) signed two separate share purchase agreements that were collectively worth RM721.61 million. The deals will see UMWOG acquire Ekuinas’ 42.3% direct stake in listed Icon Offshore Bhd for new UMWOG shares while separately acquiring Ekuinas’ 95.5% stake in privately held Orkim Sdn Bhd for cash. These exercises will see Icon Offshore being taken private.
Alongside its exit from UMWOG, UMW is also in the midst of exiting its 16 non-listed O&G businesses, which Badrul expects to be completed by next year. UMW had ventured into O&G in 2002.
The group is finalising its evaluation of the impairments needed for these O&G operations for FY2016 but it declined to specify their carrying value.
“Our job now is to recover as much value [from the non-listed O&G businesses] either via exit or selling the assets. We will evaluate them and if there is a need to impair, we will impair,” says Badrul. “We are going to start with a clean slate as far as 2017 is concerned.”
Tough road still
If all goes according to plan, UMW would only be booking its share of losses from UMWOG for another two financial quarters at most for FY2017, Badrul adds. Offloading the O&G operation will also pare some RM4.5 billion off UMW’s debt, reducing its gearing significantly.
“Moving forward, the growth strategy is to increase shareholders’ value through sustainable long-term investments,” says Badrul, adding that the plan is “to be focused on the three core businesses that we have”, given the company’s limited resources.
Analysts agree that the exercise will bring UMW an immediate upside. In a report following the Jan 19 announcement, CIMB Research expressed positive surprise, saying the exercise will remove a big drag on group earnings and better reflect growth prospects from other core businesses.
“UMW’s bottom line can easily swing into profit post-disposal of UMWOG,” says MIDF Research in a Jan 20 note. “More importantly, its balance sheet is expected to improve significantly — gearing is expected to more than halve while total borrowings will reduce by 67% based on FY15 statements.”
However, the road ahead will not be easy as UMW still has to contend with challenges in its other businesses, for example its automotive division, long a primary earnings contributor — it accounted for 74% of revenue in FY2015.
The division saw pre-tax income fall 41.6% year on year in FY2015 as revenue also fell. The decline was due to intense competition in the Malaysian automotive market while the ringgit’s depreciation against the US dollar shrank margins, UMW said.
Going into 2017, the outlook has not improved for this segment, according to Kenanga Research. “The near-term outlook for the automotive segment remains soft, evident from Perodua and Toyota’s weaker combined sales of 251,000 units in FY2016 compared with 278,000 in FY2015.
“Moving forward, we estimate flattish growth in combined sales to 254,000 units in FY2017, dragged by higher marketing operating costs, higher import costs on unfavourable currency fluctuations and lacklustre demand. We continue to believe margins will remain subdued,” says the research house.
Meanwhile, UMW’s equipment division — which distributes heavy equipment and industrial machinery across Malaysia, Singapore, Brunei, Papua New Guinea and Myanmar — saw slowing growth in FY2015 as pre-tax income inched up 3.8% year on year.
The group’s manufacturing and engineering division, which is the world’s largest distributor of Repsol lubricants outside Spain and which recently ventured into fan case manufacturing for Rolls-Royce, is still quite small, contributing just RM16.8 million to pre-tax earnings in FY2015.
Badrul, however, seems unperturbed. He tells The Edge that the group’s strategy to grow all three divisions centres on a long-term perspective and not short-term gyrations in the market.
“I believe that in the next 10 to 25 years, there will be more cycles and downtrends in the automotive, equipment or even manufacturing and engineering segments,” says Badrul. “But if we take a long-term view, we know we will stay [in the game].”
Automotive driving growth
A major part of UMW’s growth strategy is to grow its overall revenue by up to 15% over the next 5 to 10 years, according to Badrul. Taking into account the group’s FY2015 revenue of RM13.2 billion (less O&G contribution), achieving this goal would theoretically mean reaching a new revenue high of RM15.2 billion in 10 years’ time.
Badrul acknowledges that it would not be easy. A big part of that growth in the short term would have to come from the automotive division, a challenging prospect given its already high base amid the current soft market outlook.
After a record total industry volume (TIV) of 666,677 units sold in 2015, the local automotive market saw a 13% drop in 2016 to 580,124 units. Of this number, UMW lays claim to 272,220 units sold via Perodua and Toyota models, representing a market share of 47%.
A card up UMW’s sleeve is its upcoming second Toyota production plant in Bukit Raja, in which it has invested RM1.8 billion. Slated to be ready by the fourth quarter of 2018, the plant’s annual capacity will be around 50,000 units initially and may later be ramped up to 100,000 units.
The plant will boost UMW’s efficiency and capacity significantly, according to TA Research earlier this month.
In a report following a visit to the new plant, the research house opines that the new plant is necessary and long overdue for the group, given that the older plant — built in 1968 — is running below optimal utilisation due to slower Toyota sales.
According to Badrul, the plant should be fully up and running by 2019 after allowing some time to commission machines and equipment. Among others, the increased efficiency will allow more competitive pricing against UMW’s competitors, he says.
While local TIV slumped in 2016, he thinks there is light at the end of the tunnel. Badrul cites the Malaysian Automotive Association’s TIV forecast of 590,000 units for 2017, an expected 1.7% improvement.
“There is still demand out there, even though it is stabilising at around 580,000 to 590,000 units (per annum),” he says. “Hopefully, we can still sell and even conquer the majority of the 590,000 TIV.”
Part of the drive to increase the group’s market share will be an expected new Toyota model to be unveiled by the second half of 2017, Badrul adds. “Of course, continuation of aggressive promotional campaigns and more innovative strategies by car companies are needed to boost sales in this tougher economic situation.”
While the automotive division will likely remain the anchor of UMW’s earnings for the foreseeable future, reducing its reliance on this segment is also part of the group’s agenda going forward. “We aspire to have a balanced portfolio of 50% contribution from automotive and 50% from our other divisions in the long term,” says Badrul, adding though that it is unlikely that UMW’s reliance on the division will be drastically reduced in the near future, given that it is also pursuing growth in the segment.
That said, it is likely that the equipment and manufacturing and engineering divisions will outpace the automotive division’s growth rate given their lower bases, he says.
As for the equipment division, its strong base in Malaysia and Singapore with market-leading positions necessitates looking beyond those countries for further growth. UMW is studying potential new markets regionally, such as Laos and Cambodia, although it is still in initial talks with its principals.
Badrul says the strategy is to take a long-term view of 10 to 15 years to gauge whether a potential market will be moving upwards in terms of infrastructure development, which would boost the prospects for equipment suppliers such as UMW.
From that perspective, UMW is looking at “Southeast Asian countries that are booming in terms of domestic growth. Laos, Cambodia and even Thailand are growing well today”, says Badrul, adding that “there are some opportunities and we will look at them”.
In addition, UMW is looking to reposition its existing equipment operations, shifting its focus from resource-based sectors such as plantations to construction in order to cater for urbanised industries. Prospects in UMW’s sights are Putrajaya’s massive infrastructure projects announced in recent years, touted to be worth RM550 billion collectively over the next two decades.
Some of the mega projects include the mass rapid transit lines, the Pan Borneo Highway and the High-Speed Rail linking Kuala Lumpur to Singapore.
“Even if you get a small portion of that [estimated gross development value], it’s already a huge market,” says Badrul. “We are also evaluating some opportunities in industrial equipment leasing, in terms of the pros and cons.”
In the manufacturing and engineering division, Badrul is optimistic about the group’s upcoming single-source Tier-1 Rolls-Royce plant, which will begin operations in October this year. The plant, which cost RM750 million, will produce fan cases for Rolls-Royce under a 25-year agreement that will be used for the Boeing 787 Dreamliner and Airbus A330neo.
“We will produce a single-digit number of fan cases this year, move to two digits in 2018 and to three digits in 2019,” says Badrul. “The plant will start contributing positively [to earnings] in 2019 and we are looking at manufacturing and engineering being one of the core contributors to the group’s bottom line in 2020.”
While Badrul declined to disclose the expected contribution from the plant, he says it will be “significant” to the manufacturing and engineering segment. If all goes well, the plant will be UMW’s launch pad to further high-value, high-margin manufacturing opportunities.
Airbus, for example, reportedly had a backlog of orders worth US$1 trillion as at end-2016. “There is a huge opportunity there,” says Badrul. That said, he is wary of UMW getting too far ahead in terms of manufacturing and engineering diversification. For now, the focus is getting the fan case manufacturing plant up and running smoothly.
“I have told the team to focus on Rolls-Royce right now, make sure they deliver and deliver it right and at the right quality. Then, if there are any other opportunities, we will take a look,” Badrul says.
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