MARC has assigned a preliminary rating of AA-IS to DRB-HICOM Berhad's (DRB-HICOM) proposed RM1.8 billion Islamic Medium-Term Notes Programme with a stable outlook pending final documentation review.

The structure for the issuance of sukuk under the rated programme is based on the Shariah principle of murabahah. In the first leg of the murabahah transaction, DRB-HICOM will purchase Shariah-compliant commodities on behalf of sukukholders equal to the amounts disbursed under the murabahah facility. The commodities will be purchased by DRB-HICOM from the sukukholders' appointed agent in the Bursa Suq Al Sila at cost price plus a profit margin on a deferred basis in the second leg of the transaction. DRB-HICOM will then sell the commodities for cash proceeds that will be used to refinance existing debt and for other corporate purposes.

MARC's rating on the programme is entirely based on the credit risk of DRB-HICOM, a holding company with diverse interests in the automotive, service concessions, financial services and property sectors. The rating reflects the group's business line diversity which should contribute to higher earnings stability over time, a strong market position in the domestic automotive industry, the overall positive momentum in group operating profitability, the reasonable dividend capacity of operating subsidiaries and the holding company's manageable debt maturity profile.

Partly offsetting these strengths is the anticipated weakening of the credit metrics of the holding company and the group relative to March 31, 2011 (FY2011) levels, stemming from a high level of investment activity. Most of the proceeds from the 15-year programme will be used to fund three key long-term strategic investments which include DRB-HICOM's 32.2% stake in national postal services operator POS Malaysia Berhad (POS Malaysia), capital spending for its joint venture with Volkswagen AG (Volkswagen) to assemble cars, and an automotive university college.

MARC sees some uncertainty with respect to the ability of the POS Malaysia and automotive university college investments to deliver or support meaningful profit and cash flow generation in the short- to medium-term. While the rating agency perceives DRB-HICOM's investment in POS Malaysia to be strategically positive, it also believes that the group will face considerable challenges in the execution of the postal banking strategy in particular. The regulatory requirement for DRB-HICOM to dilute its stake in Bank Muamalat Berhad (Bank Muamalat) to 40% from 70% currently creates further uncertainty around strategy implementation.

DRB-HICOM is the country's third largest automotive player with a market share of 17.9% of total industry vehicles sold in 2010. It participates in four broad automotive segments: the passenger, commercial, mass transport and defence automotive segments. It assembles premium cars under Mercedes Benz brand as well as assembles and distributes Honda, Suzuki and Isuzu brands among others.

DRB-HICOM's automotive segment contributed 59% and 57% of the group's revenue and pre-tax profit respectively for FY2011. The group's committed investment of RM500.0 million in the extension of its Pekan plant to accommodate local assembly of Volkswagen cars would be beneficial to the operating and financial performance of the group's automotive segment going forward. Good long-term earnings visibility for its defence automotive business, meanwhile, is afforded by a recently awarded RM7.55 billion contract to manufacture and deliver 257 armoured wheeled vehicles to the Malaysian government over a seven-year period.

The group has increased its business diversification over the years, which MARC considers to be broadly positive. Its banking segment, for instance, accounted for a fairly sizeable 12% and 25% of the group's revenue and pre-tax profit respectively for FY2011. At the same time, the rating agency notes the subdued contributions to the group's bottom line by its property and services segments, with the exception of its power plant operations and maintenance business which continue to exhibit above-average earnings and dividend paying capacity. A near- to medium-term challenge facing the group is improving the profitability of its commercial vehicle inspection and solid waste management concessions, and to turn around its loss-making property segment.

As an investment holding company, DRB-HICOM's revenue is derived mainly from dividends from its operating subsidiaries. Based on the historical and/or projected dividend paying capacity of its operating subsidiaries as well as projected debt repayments, DRB-HICOM's anticipated debt service coverage measures imply comfortable covenant headroom. Annual dividends are projected to be RM268.0 million on average for the three-year period from FY2013 to FY2015 before rising above RM300.0 million in FY2016 and thereafter. MARC takes note of the modest debt maturities projected through FY2016 and the significant financial flexibility afforded by the IMTN programme in relation to using generated cash flow to pay down debt.

DRB-HICOM's moderately leveraged balance sheet and non-core assets such as its equity stakes in Bank Muamalat and insurance holding company Uni Asia Capital Sdn Bhd provide additional financial flexibility. Holding company debt leverage, measured as debt-to-equity, is not expected to exceed 0.5 times on a pro-forma basis assuming full drawdown of the RM1.8 billion financing facility.

The stable outlook reflects MARC's expectation that the company and the group will sustain credit metrics appropriate for its current rating level over the next 12 to 18 months in a more uncertain macro-economic environment.

Contacts: 
Darrell Lim,  +603-2082 2261/ darrell@marc.com.my;
Rajan Paramesran, +603-2082 2233/ rajan@marc.com.my.