MARC has affirmed its ratings of AA-_IS and A_IS on DRB-HICOM Berhad’s (DRB-HICOM) Islamic Medium-Term Notes (IMTN) Programme of up to RM1.8 billion and Perpetual Sukuk Musharakah Programme (Perpetual Sukuk) of up to RM2.0 billion respectively. The ratings outlook has been revised to negative from stable.

The outlook revision is mainly driven by the impact of the challenges in the domestic automotive industry on the group’s key automotive subsidiary, Proton Holdings Berhad (Proton), as it contends with increased competition and weakening consumer sentiment. The support extended to Proton by way of advances from the holding company to meet ongoing capital expenditure would continue to exert pressure on the group’s credit profile. In addition, the weakening prospects for the group’s non-automotive segments, mainly the property segment, has weighed on the group’s financial metrics.

DRB-HICOM’s senior debt rating incorporates its favourable market position in the domestic automotive industry, its moderately diversified earnings stream and its adequate liquidity position. The group’s increased borrowings, including drawdowns under the rated Perpetual Sukuk, to accommodate expansion and acquisition plans remain a rating concern. Contributing about 79.0% and 40.4% to group revenue and pre-tax profit for financial year ended March 31, 2015 (FY2015), the automotive division has several marques in its stable, including Honda, Proton and Mitsubishi. The group’s market position is reflected in its fairly large contribution of 36.1% to the total industry volume (TIV) of 319,648 units sold for 1HFY2016 (FY2015: 33.7%).

The automotive division’s sustained performance is attributable mainly to its Honda range, while sales of Proton marques have remained weak, declining by 12.7% y-o-y to 50,615 units in 1HFY2016 (1HFY2015: 58,015 units). In particular, its most recent launch Proton Iriz saw weaker-than-expected sales. To boost sales, Proton will launch the new Proton Saga facelift model and new variants of the Persona and Perdana models in 2016. However, given the stiff competition in the domestic automotive industry, the automaker is likely to meet challenges. Under an initiative to increase consumer confidence in managing customer issues, Proton recently announced a service fix of about 95,000 Exora, Preve and Suprima model units to replace a potentially faulty part. The impact of the service fix on Proton’s earnings is expected to be minimal.

MARC notes that to meet Proton’s funding requirements for its new models, about RM691.0 million of the RM1,040 million sukuk DRB-HICOM had issued under the RM2.0 billion Perpetual Sukuk programme has been onlent to the carmaker. Proton’s financial performance continued to be weighed down by thin margins and sizeable financial commitments, including a RM268.5 million annual term loan payment arising from the restructure of debt obligations of its subsidiary Lotus Group International Limited (Lotus). Following the business and financial restructuring of Lotus, its sports car sales have steadily improved to 2,105 units for FY2015 (FY2014: 1,301 units), narrowing operating losses to negative GBP35.6 million (FY2014: negative GBP71.7 million). The automotive division is also supported by defence contractor DRB-HICOM Defence Technologies Sdn Bhd (DEFTECH), which has delivered 28 armoured vehicle units as at end-December 2015 and is targeting to deliver another 42 armoured vehicles in 2016 under a RM7.6 billion contract with the Ministry of Defence. The group’s property division has remained relatively subdued in respect of property development activities, instead generating cash flow from disposal of assets, namely an 8-storey shopping mall recently, and land parcels. With a sizeable 2,864 acres of landbank, the division would be able to undertake further disposals.

The group’s other key non-automotive segment, namely the services division as represented by Alam Flora Sdn Bhd and PUSPAKOM Sdn Bhd, both of which have long-term concessions with the government, have continued to generate moderate earnings and dividends. In contrast, its 70%-held banking subsidiary Bank Muamalat Malaysia Berhad (Bank Muamalat) is unable to upstream any dividends unless its stake is reduced to below 40%, a condition stipulated by Bank Negara Malaysia (BNM) to facilitate any cash dividend payout by the bank. In this regard, MARC observes DRB-HICOM’s efforts to reduce its stake through merger and share divestment, including the recent proposed merger with Malaysian Building Society Berhad (MBSB), have not been successful. The holding company is now planning to undertake an initial public offering of the bank by end-2016 to resolve the longstanding issues concerning the divestment of the bank.

For 1HFY2016, DRB-HICOM’s consolidated revenue declined by 10.7% y-o-y to RM6.2 billion while pre-tax profit fell sharply by 80.8% y-o-y to RM69.4 million, largely attributable to losses at its largest auto subsidiary, Proton. The group’s consolidated borrowings increased to RM7.5 billion as at end-1HFY2016 while the leverage ratio stood at 0.83 times on the back of a higher capital base from the 50% equity credit assigned to the Perpetual Sukuk (FY2015: RM7.3 billion; 0.82 times). At the holding company level, DRB-HICOM’s revenue and pre-tax profit decreased to RM305.2 million and RM126.5 million respectively in FY2015 (FY2014: RM707.9 million; RM491.4 million) in the absence of any major disposal exercise as compared to the previous year. The borrowings level stood higher at RM3.1 billion, while leverage remained flat at 0.48 times (FY2014: RM2.9 billion; 0.49 times).

Over the near term, DRB-HICOM’s ratings could come under pressure should any weakening in the group’s financial performance further drag its consolidated financial metrics to a level that is no longer commensurate with the current rating band. Downward pressure would also arise if margins deteriorate and/or if any increase in borrowings to fund acquisitions are not adequately compensated with earnings generation. Conversely, improvement in the group’s consolidated earnings and cash flow generation could cause the outlook to be revised back to stable.

Contacts:
Saifuruddin Othman +603-2082 2245 / saifuruddin@marc.com.my;
Cheah Wan Kin +603-2082 2232 / wankin@marc.com.my;
Taufiq Kamal, +603-2082 2251 / taufiq@marc.com.my.