• Catalist-listed MeGroup is an approved component supplier and car dealer that is levered to Malaysia’s auto industry volumes. 
• It recently received its third Peugeot dealership and has more in the pipeline. 
• The company expects to incur one-off costs in FY3/19F for listing fees and higher borrowings. 

Background

Indirect proxy to 70% of Malaysia’s auto market 

• Listed on the Singapore Exchange Catalist Board since 30 Oct 2018, MEGROUP LTD. (SGX:SJY)’s main businesses comprise both the manufacturing and dealership segments in Malaysia’s automotive industry. Some of its new and long-standing customers include Perodua, Honda, Proton and Geely, Mazda and Johnson Controls-Hitachi.
• MeGroup has presence in Balakong, Selangor and Batu Kawan, Penang (for manufacturing), as well as Klang Valley and Seremban (for dealership).
• Not only is it a noise, vibration and harshness (NVH) components maker, MeGroup also owns and operates several 3S and 4S automobile dealerships under the Honda, Mazda and Peugeot brands across Malaysia.
  • Manufacturing – noise, vibration and harshness (NVH) components such as headliners and engine outers that are incorporated into various parts of automobiles; and non-NVH parts that include parcel trays and board assembly decks.
  • Dealership – owns and operates 3S and 4S automobile dealerships under the Honda, Mazda and Peugeot brands. This adopts a franchise model that comes with fixed margins and performance incentives.
• (Type of service offerings dealerships: 1S: sale of new automobiles; 2S: provision of after-sales services; 3S: sale of automobile parts and accessories; 4S: automobile body paintwork and collision repair services.)

Business Updates

Expanding portfolio of dealerships in Malaysia

• MeGroup currently owns and operates two 3S Honda dealerships, one 4S Mazda dealership and two 4S Peugeot dealerships. Post listing, the group not only clinched its third Peugeot automobile dealership (3S) in Setia Alam Selangor, Malaysia, but is also in the process of upgrading one of its 3S Honda dealership to 4S.
• While upgrading of service type typically requires capex of no more than RM3m, the company estimates this could add 1-2% pts to the gross margin. In FY18, the group recorded gross margin of 6.7% for the dealership segment, to which management sees upside potential as some outlets have yet to mature and each outlet typically takes 2-3 years to achieve consistent sales growth, depending on its location.
• With its new listing status and S$2.4m net IPO proceeds, MeGroup seeks to expand more aggressively via both organic and inorganic means. One of its growth strategies include entering into new brand partnerships, diversifying into the reconditioned and used cars industry, or establishing new sites, given its track record. Management believes the highly fragmented auto dealership market is poised for consolidation, which could present acquisition opportunities as many traditionally-run dealerships are unable to compete in the market and may consider cashing out.

Diversifying into HVAC for manufacturing

• Under the manufacturing segment, MeGroup operates two plants (main manufacturing and thermobonded felt) in Selangor, Malaysia, as well as one assembly line in Penang for Mazda components. It is the Approved Supplier for Honda Malaysia, Perodua Manufacturing, Perodua Global Manufacturing, Mazda Malaysia, Perusahaan Otomobil Nasional (Proton) and Johnson Controls-Hitachi to supply NVH and non-NVH components.
• While the company is currently producing 3-10 parts per car, management believes MeGroup has the potential to manufacture up to 50-100 parts. This segment offers attractive gross margins of 30-40%, and relatively stable income stream given the 3- to 5-year product lifecycle of the auto parts.
• With average utilisation rate of 60% currently, management thinks the new orders for heating, ventilation and air-conditioning (HVAC) from Johnson Controls-Hitachi would commence sales contribution in FY19F and improve its operating margins.

Potential government tailwinds for automotive sector

• Based on Malaysian Automotive Association statistics, automobile sales volume surged in 2018 thanks to a three-month tax holiday. While such tax relief was short-lived, industry players believe multiple new model launches by Perodua, UMW Toyota Motor [a subsidiary of UMW Holdings (UMWH MK)] and Bermaz Auto (BAUTO MK), especially in the mass-market segment, could support automobile sales in 2019F.
• Management views Malaysia’s National Automotive Policy changes and the third Malaysia National Car Project favourably, as they could provide opportunities for more manufacturing projects for MeGroup, particularly for electric vehicles that require stricter quality of vehicle insulation and possibly increase the value/number of parts to be manufactured. The government’s decision on end-of-life vehicle policy could also change consumers’ purchasing behaviour and after-sales service market, thus affecting companies like MeGroup.

Financials

Earnings volatility caused by exogenous events

• In FY16-18, MeGroup’s revenue from manufacturing grew steadily as the volume of NVH and non-NVH components supplied to customers increased. However, this was offset by volatile sales contribution from the dealership segment, which fluctuates in tandem with the auto sector’s total industry volume in Malaysia.
• MeGroup’s 1HFY19 revenue surged 121.5% y-o-y as the tax-free holiday from Jun to Aug 2018 incentivised more vehicle purchases.
• Despite the rising topline, FY17-18 net profit was distorted by one-off items.
  • In FY17, one of MeGroup’s main factory in Balakong, Malaysia suffered extensive fire damage and wrote off property, plant and equipment (PPE) damages of RM12.5m. The group subsequently obtained an insurance claim of RM20.9m.
  • In the following year, MeGroup received RM4.8m compensation from the Malaysian government, as its showroom located in Kuala Lumpur had to be written off due to compulsory acquisition by the government for the Mass Rapid Transit Project. Excluding this, MeGroup’s 1HFY19 core net profit would still have improved 17.5% y-o-y to RM3.1m (1HFY18 core net profit: RM2.6m).

One-off expenses in FY19F

• According to its prospectus, MeGroup expects to register lower net profit in FY19F vs. FY18 due to the following one-off items:
  1. listing fees,
  2. absence of net gain of RM4.83m from the Malaysian government to compensate for relocating Mazda dealership in FY18, as well as
  3. higher financing costs due to additional loans taken for the upgrading of its Honda 3S Dealership at Jalan RS and the construction of a new Honda 3S Dealership facility in Selangor, Malaysia.

Healthy balance sheet, positive operating cash flow

• As at end Sep-2018, MeGroup’s net gearing ratio was 0.33x. Together with strong cash flow generation, this provides sufficient debt headroom to undertake more acquisitions and capex investment to pursue growth.

Dividend policy

• MeGroup currently does not have a formal dividend policy.

Valuation

• MeGroup currently trades at a historical 14.3x FY3/18 P/E (and slightly below its IPO price of S$0.23), which translates into a 20% discount to the regional auto industry average of 18.4x CY18F P/E (based on our estimates). See attached PDF report for comparison on MeGroup's regional peers.

Source: CGS-CIMB Research - 05 Mar 2019