DRB-Hicom Bhd - 2014

MARC has assigned a final rating of AIS to DRB-HICOM Berhad’s (DRB-HICOM) Perpetual Sukuk Musharakah Programme (Perpetual Sukuk) of up to RM2.0 billion. Concurrently, the rating agency has affirmed its AA-IS rating on DRB-HICOM’s existing Islamic Medium-Term Notes (IMTN) Programme of up to RM1.8 billion. Both ratings carry a stable outlook.  The two-notch rating differential between the Perpetual Sukuk and IMTN is in line with MARC’s notching principles on hybrid securities. Among its key features, the proposed Perpetual Sukuk is non-callable within five years of issuance and has profit distributions that are cumulative and deferrable on an unlimited timeline. Accordingly, MARC has given 50% equity credit on the Perpetual Sukuk, which ranks above DRB-HICOM’s ordinary shares in the absence of other subordinated debts that are senior to the proposed programme.

The affirmed rating on the IMTN incorporates DRB-HICOM group’s strong market position in the domestic automotive industry, underpinned by a diverse range of car marques and a long operational track record. The rating is also supported by a moderately diversified revenue stream from other businesses that include concessions, logistics and property development. The ratings are, however, constrained by the group’s large borrowings and its continued reliance on external funding to accommodate expansion and acquisition plans. Additionally, the group’s automotive segment remains sensitive to regulatory policy changes and consumer sentiment in an increasingly competitive environment in which DRB-HICOM continues to face challenges to improve the business and financial profile of its wholly-owned car manufacturing subsidiary, Proton Holdings Berhad (Proton).

Proceeds from the proposed Perpetual Sukuk are expected to be largely channeled to Proton to fund the company’s working capital and developmental expenditures. The national carmaker continues to manufacture and sell a steady volume of cars (April-July 2014: 43,000; FY2014: 142,000; FY2013: 140,000) and has recently introduced a compact model, Proton Iriz, to target the middle-income group. The sales performance of this model as well as its older ones would remain key to improving Proton’s credit profile. On a positive note, the completion of the debt restructuring of its subsidiary Lotus Group International Limited’s (Lotus) £207.3 million borrowings (about RM1.1 billion) into longer-tenured debt has alleviated short-term liquidity concerns. This notwithstanding, Proton’s debt level rose by 24.1% year-on-year to RM1.79 billion, which led to an increase in the car manufacturer’s debt-to-equity (DE) ratio to 0.58 times for financial year ended March 31, 2014 (FY2014) (FY2013: 0.38 times). Proton reported a lower post-tax loss to RM461.6 million in FY2014 from post-tax loss of RM821.7 million in the previous year, mainly due to lower administrative and impairment charges on intangible assets related to Lotus.

Apart from Proton, DRB-HICOM’s automotive division produced and distributed over 93,000 vehicles of other marques, including Honda and Audi. The automotive division accounted for 35.8% of the country’s total industry volume in FY2014 (FY2013: 34.1%). Going forward, sales performance is expected to be driven by the higher production capacity for its Honda franchise, supported by the introduction of two new models in 2013. Additionally, the segment’s performance could receive a boost from the delivery of 12 armoured vehicles in FY2015 to the Malaysian army by its subsidiary DRB-HICOM Defence Technologies Sdn Bhd (DEFTECH) under a RM7.55 billion contract; the delivery is expected to peak in 2016/17. DRB-HICOM’s services division, as represented by Alam Flora Sdn Bhd and PUSPAKOM Sdn Bhd, has continued to generate moderate earnings. Meanwhile, efforts to divest its 70% interest in Bank Muamalat Malaysia Berhad to 40% are continuing; however, MARC understands that no definitive timeline has been established.
 
For end-September 2014 (1HFY2015), the group registered revenue of RM6.9 billion (1HFY2014: RM6.7 billion) and profit before tax of RM361.2 million (1HFY2014: RM323.8 million) in part due to improved performance of its automotive division. Group consolidated debt increased to RM7.1 billion as at end-1HFY2015 (FY2013: RM6.5 billion) mainly due to the debt-funded acquisitions of Konsortium Logistik Berhad (KLB) for RM391.1 million in April 2014 and Composite Technology Research Malaysia (CTRM) for RM298.3 million in January 2014. As a result, group leverage rose to 0.84 times at end-FY2014 (FY2014: 0.84 times, FY2013: 0.78 times). 

At the holding company level, DRB-HICOM’s revenue and pre-tax profit increased to RM707.9 million and RM491.4 million respectively in FY2014 (FY2013: RM649.6 million; RM380.9 million) largely due to higher dividends received from the disposal of Uni.Asia Life during the year. DRB-HICOM met its scheduled debt repayment of about RM477.2 million in FY2014, following which borrowings declined to about RM2.9 billion (FY2013: RM3.4 billion). With cash and cash equivalent standing at RM224.6 million at end-FY2014, the adjusted net debt-to-equity (DE) ratio improved to 0.45 times from 0.59 times in FY2013. MARC expects debt repayments at the holding company level to continue to be supported by steady dividend income from the group’s operating subsidiaries, projected at an average of RM500.0 million per annum from FY2015-19. In addition, the ability to draw down on the Perpetual Sukuk for the balance of the proceeds will provide some financial flexibility to partly address the holding company’s financial obligations.

The stable outlook incorporates MARC’s expectations that DRB-HICOM will maintain a credit profile that is commensurate with the current rating band over the next 12 to 18 months. The ratings could come under pressure if borrowing levels were to increase significantly to accommodate further acquisitions and/or expansions such that the interest and debt coverage levels are no longer compatible with the given ratings. Additionally, any weakening of the group business profile would have negative implications on the ratings. 

Strengths

• Major player in the domestic automotive industry;
• Moderately diversified business portfolio that includes concession assets and property projects; and
• Improving group financial profile.

Challenges/Risks

• Generating stable earnings from operations;
• Exercising balance sheet discipline in respect of debt-funded acquisitions; and
• Susceptibility of key businesses to regulatory policy changes and consumer sentiment.