UMW Holdings Bhd - 2013

MARC has downgraded its long-term Islamic debt ratings on UMW Holdings Berhad’s (UMW) RM300 million Islamic Commercial Paper/Islamic Medium Term Notes (ICP/IMTN) Programme to AA+ID from AAAID. The rating agency also affirmed its short-term rating on the programme at  MARC-1ID. MARC subsequently withdrew all ratings on UMW at its request. The outlook was stable at the time of the withdrawal. MARC’s rating analysis had been based solely on publicly available information due to non-cooperation from the issuer.

The downgrade was mainly driven by MARC’s reassessment of the group’s business risk profile, taking into account (i) UMW’s recent growth focus on oilfield support operations where the rating agency regards business risks to be higher; (ii) the concentration of revenue and earnings in its automotive segment notwithstanding the rising proportion of total consolidated assets accounted for by non-automotive operations; and (iii) challenges in the local automotive industry overall. The downgrade also incorporated the continuation of UMW’s high dividend policy, its dependence on cash dividends from its largest operating subsidiary, and the structural subordination of the holding company’s debt to the direct obligations of its subsidiaries.

Prior to the rating change, MARC’s view of the group’s and holding company’s credit profile had been primarily driven by the credit strength of its automotive operations. As a result of the reassessment of the group’s business risk profile and the still somewhat aggressive financial policy at UMW company-level, MARC opined that the holding company’s overall credit quality was more appropriately positioned at ‘AA+’.

The AA+ rating also reflected structural subordination resulting from UMW's holding company structure. Its cash flow and ability to service its debt are dependent upon the earnings of its operating subsidiaries, as well as distributions by and repayments from its subsidiaries. Accordingly, the holding company's debt is structurally subordinated to the direct obligations of its subsidiaries, which has generally been on an upward trend over recent years. As of end-2012, the holding company's borrowings of RM799.6 million represented 27.8% of group borrowings (end-2012: RM2.88 billion, up from RM2.59 billion as of end-2011).  Dividend flows will be contingent upon its operating subsidiaries' performance and business considerations, including growth-related funding needs of the subsidiaries which will likely remain elevated for UMW's oilfield support operations. Apart from repayments of amounts due from subsidiaries, MARC believed that dividend payouts from the 51%-owned UMW Toyota Motor Sdn Bhd will remain a key source of cash flow for the holding company, as historically observed.
 
The lowered rating also incorporated UMW's increased willingness to undertake a more aggressive financial strategy, as evidenced by the increased leverage at the holding company in recent periods and a more aggressive liquidity position relative to most issuers similarly rated at ‘AA’ band by MARC. The holding company has utilised the proceeds from incremental leverage to grow the group's non-automotive business while continuing to return significant amounts of cash to shareholders in the form of dividends.

MARC estimated that holding company level debt, which stood at RM799.6 million as at end-2012, would potentially increase to RM1.24 billion following the net issuance of RM440.0 million under its new RM2.0 billion  IMTN  programme, resulting in an increase in the debt-equity (DE) ratio to 0.79 times (end-2012: 0.51 times). That said, MARC noted the projected repayment of inter-company indebtedness of RM597.4 million to UMW by its oil and gas subsidiary UMW Oil and Gas Corporation Berhad (UMWOG) from the expected proceeds of its forthcoming initial public offering (IPO) exercise. This, and proceeds generated from the sale of a portion of equity in the subsidiary via the IPO (estimated to be around RM647.9 million) should allow UMW’s leverage metrics to be restored to a more conservative level. However, MARC expected UMW’s aggressive shareholder dividend policy of returning at least 50% of net profit attributable to its shareholders after excluding unrealised profits to continue to impede free cash flow generation on a sustained basis.

For financial year ended December 31, 2012 (FY2012), UMW’s automotive segment contributed about 72.5% to group revenue and 89.4% to group pre-tax profit. While the group’s automotive segment has maintained its leadership position in the national and non-national automotive segments, MARC believed that the intense competition in the domestic automotive market and household debt affordability issues will ultimately weigh on its operating margins and sales growth. Meanwhile, UMW’s oil and gas division registered turnaround pre-tax profit of RM57.7 million for the first time since FY2009. The sustainability of the division’s performance will be dependent on its ability to secure and replenish service contracts in the context of a volatile and cyclical operating environment. For first quarter ending March 31, 2013 (1QFY2013), the UMW group registered pre-tax profit of RM432.7 million on revenue of RM3.4 billion (1QFY2012: RM436.7 million; RM3.7 billion) due mainly to lower contributions from the automotive and oil and gas segments.