Special Report: SST exemption a breather, headwinds remain for auto sector

This article first appeared in The Edge Malaysia Weekly, on June 27, 2022 - July 03, 2022.
Special Report: SST exemption a breather, headwinds remain for auto sector
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AUTOMOTIVE companies heaved a sigh of relief after the government decided last week to allow those who place their bookings before June 30, 2022 to still enjoy the sales and services tax (SST) holiday as long as their cars are registered by March 31, 2023.

Automotive executives are largely happy with this development — with the clarity provided by the decision, most of the estimated 80,000 backlog orders will now probably not be cancelled.

“To the auto industry players, it is a win-win situation when potential buyers would still get their passengers cars at the SST tax holiday rate provided [the] booking [is] received by June 30 and registered by March 31, 2023.

“At least there will be no cancellation of orders and customers can be pacified. We hope the world shortage in the supply of microchips would be resolved by then,” says president of the Malaysian Automotive Association (MAA) Datuk Aishah Ahmad.

The SST exemption, first announced on June 5, 2020 as part of the Penjana stimulus package, has been a lifeline for automotive companies over the last two years. This can be seen from the sale of passenger cars between June 2020 and May 2022. However, even with the SST exemption, total industry volume (TIV) between 2020 and 2021 declined year on year, due to the various Movement Control Orders to curb the spread of Covid-19 last year.

In 2021, the Malaysian automotive market chalked up a TIV of 508,911 units, a 3.9% drop from 2020. From January to May this year, TIV stood at 265,656 units, a more than 7% increase from the 247,250 units registered in the same period in 2021.

This shows that the SST exemption has helped the automotive market withstand a myriad of challenges. As such, it is no surprise that the industry was lobbying hard for the government to extend the SST exemption beyond June 30.

No revival

However, the fact that more car buyers could enjoy the SST exemption, leading to a surge in sales, does not mean the sector will see a revival. This is because chip supply is still an issue, although some industry players say the shortage is easing.

Moreover, the possibility of the government implementing new ways of calculating the open market value (OMV) of cars starting next year still hangs over the automotive players.

Recall that the revised method to calculate OMV, on which the excise duty on cars is imposed, had been gazetted by the Pakatan Harapan government in late 2019. However, due to the Covid-19 pandemic over the last two years, the revised regulation has not been implemented.

Under the revised method, the OMV of a car will include sales costs, such as advertisement and promotion, marketing, warranty and commissions, in addition to just manufacturing cost. This will increase the OMV of a locally-assembled car, as previously, the value is just the ex-factory price.

In a report dated March 28, MIDF Research’s analyst Hafriz Hezry noted that the revised OMV calculation is a potential risk to auto sector duty costs, and ultimately sales volume, if the increase in duty costs is passed on.

In the report, he said the government should consider a rebate mechanism for the incremental OMV base coming from sales-related costs, which are mostly locally incurred and ultimately provide value-add to the domestic economy, similar to the current excise duty system that rewards the local content of a vehicle.

“In any case, any changes should only be done gradually in order to allow industry players and the market to adapt to the changes, in our opinion,” Hafriz said in the report.

According to estimates by MAA, the revised way of calculating OMV will result in increases of between 8% and 20% in the prices of locally-assembled cars.

If this new way of calculation is implemented in 2023, and with no exemptions on SST, prices of locally-assembled cars could increase drastically.

As it stands, MAA has sent a letter to the Ministry of Finance (MOF) to appeal against the implementation of the revised way of calculating OMV and asked the government to inform the industry first if it plans to go ahead with the implementation in 2023. “We have still not received MOF’s final approval letter (on the appeal to delay the implementation of the new OMV calculation),” says Aishah in a text message in response to The Edge’s queries. However, she says the MOF is “looking positively” at MAA’s appeal.

If the new OMV calculation is implemented, it will impact most automotive companies, including those that have been doing well recently.

Bermaz Auto Bhd (Bermaz) is also concerned about the implementation of the new OMV calculation. This is because 70% of Bermaz’s domestic sales comes from completely-knocked down (CKD) models, including the Mazda CX5 and CX8 crossovers, and the Peugeot 2008, 3008 and 5008.

In the financial year ended April 30, 2022 (FY2022), Bermaz recorded a net profit of RM155.72 million, an increase of 16.35% y-o-y. It was the second consecutive year that Bermaz recorded an increase in its profitability.

The shortage of chips and parts that most of the automotive industry is suffering from did not seem to have affected Bermaz in FY2021 and FY2022. However, the group is still worried about the double-whammy impact of the revision of the OMV as well as a weakening ringgit and rising costs.

“Well, at least our bookings will last until end-March 2023. So, the impact (of the revision of the OMV), if any, will only be felt from April 1 onwards next year. [But] with rising raw material costs, it could be a double whammy for cost increase,” says Bermaz CEO Datuk Francis Lee Kok Chuan when contacted.

“We will be affected as well. The saving grace is that everyone will be affected at the same time,” he adds.

Automotive companies with large CKD operations will be impacted if the revised OMV calculation is implemented.

UMW Holdings Bhd through its subsidiary UMW Toyota Motor Sdn Bhd assembles Toyota models at its plants in Bukit Raja, Klang, while DRB-Hicom Bhd assembles Mercedes-Benz and Volkswagen models in Pekan, Pahang. The latter also owns a stake in Honda Malaysia Sdn Bhd, which has an assembly plant in Pegoh, Melaka.

Tan Chong Motor Holdings Bhd assembles models from Japanese marques Subaru, Nissan and Mitsubishi at its plants in Segambut and Serendah, Selangor.

Meanwhile, foreign automotive groups that have assembly plants in Malaysia include Volvo Car Corporation with a plant in Shah Alam, and Stellantis NV with a plant in Gurun, Kedah, assembling Peugeot and Citroën models.

Strong US dollar weighs on local automakers  

Besides the possibility of the implementation of the new OMV calculation, the automotive industry could also be hurt by the depreciation of the ringgit against the US dollar, which caused an increase in the cost of some raw materials and automotive parts.

If the ringgit continues to depreciate against the US dollar — year-to-date, the local currency has fallen 5.75% against the greenback — the cost of living will rise and therefore erode the purchasing power of the people. Automotive sales — an indication of consumer confidence in the country’s economy — will be among the first to be affected by a rising cost of living.

The US Federal Reserve plans to continue raising the Federal funds rate to combat runaway inflation in the US. The Fed’s benchmark rate is projected to end the year at 3.4%, from the current 1.5% to 1.75%, and 3.8% in 2023.

This could lead to central banks in emerging economies including Bank Negara Malaysia reacting to the Fed’s hawkish stance to ensure that the ringgit remains stable against the greenback. Bank Negara surprised the market with a 25 basis point hike in the overnight policy rate to 2% in May, in response to inflationary pressures resulting from the reopening of the economy and improved labour market conditions.

This could translate into pricier loans for large-ticket items including cars, eventually dampening demand.

A weaker ringgit against the greenback means that raw materials that are traded in US dollars, such as polymers and other petrochemicals used in the production of automotive parts, will be more expensive for local assemblers.

On top of the weaker ringgit, the prices of these raw materials themselves have increased due to the global supply chain shocks.

Looking at the movement of the ringgit against the currencies of major trading partners, the local currency is still stronger compared with the Japanese yen. This means assemblers of Japanese marques that source their CKD kits from the country could still withstand the economic headwinds.

Year-to-date, the ringgit has appreciated 11.29% against the Japanese yen as at last Thursday, closing at 3.2517 per ¥100. Meanwhile, the ringgit is still quite stable against the euro so far this year. Year-to-date, the local currency is up 1.88% against the euro at 4.6388 as at last Thursday.

Hafriz of MIDF Research says in a June 21 report that industry players are indicating the possibility of passing on these costs via price hikes, though at this juncture, price increases are still selective.

“We anticipate the non-nationals to be in a better position to pass on incremental cost relative to national cars given that the latter typically entails a price-sensitive customer profile,” states Hafriz in the report.

Amid all these factors, the extension in the SST exemption to March 31, 2023 is really just a breather to the automotive sector. It looks like industry players still have their work cut out for them.  

 

Analysts positive on exemption allowance, but say fine-tuning needed

Analysts are largely positive on the allowance for cars to be registered by March 31, 2023 to enjoy the Sales and Service Tax (SST) exemption. However, they say the policy needs fine-tuning as it could be abused by customers. The government also ought to look at the net impact of the policy on its revenue.

Maybank Investment Bank Research analyst Liaw Thong Jung writes in a report last Tuesday that the decision could give rise to speculative bookings until the end of this month, which is a disservice to automotive salesmen and dealers.

“It will likely create many unnecessary operational issues. First, speculative bookings will rise over the next 10 days (since June 21). It is envisaged that many prospective and speculative buyers will take advantage of this outcome and place token deposit bookings, just to lock in orders.

“That would skew bookings, for prospective buyers can cancel and/or transfer their orders and secure deposit refunds anytime, which poses an unnecessary disservice to salesmen/dealers,” he says in the report.

He adds that another potential outcome is that some not so time-sensitive buyers may place orders by end-June 2022 but could request a 2023 delivery, to save from depreciation.

“This could result in weaker TIV [total industry volume] in the second half of this year and strong TIV in the first quarter of 2023,” says Liaw.

He also says that the policy could result in lower excise duty being collected as TIV falls following the expiry of the SST exemption. The government has noted the loss of an estimated RM4.7 billion in revenue from the SST exemption since June 2020.

“While the revenue loss from the SST loss totalled RM4.7 billion [according to the Ministry of Finance], we reckon the revenue gained from the excise and import duties collected during the period far outweighs the SST loss.

“Without the SST holidays, collections from excise and import duties will likely come in lower on lower vehicle sales. Excise duties alone accounted for 67% of auto tax in 2019 (pre-SST exemption),” opines Liaw.

Nevertheless, he has a positive outlook on the automotive sector, with “buy” calls on Sime Darby Bhd (target price: RM2.70); UMW Holdings Bhd (TP: RM5.00); Bermaz Auto Bhd (BAuto, TP: RM2.90); MBM Resources Bhd (MBMR, TP: RM4.60); and Tan Chong Motor Holdings Bhd (TP: RM1.35).

Meanwhile, Kenanga Research analyst Wan Mustaqim Wan Ab Aziz opines that car sales will remain sustainable after the SST exemption period. He believes order cancellations would be minimal as demand would still outweigh supply, given the massive backlog of orders accumulated since last year.

“The current backlog, as shared by the Ministry of Finance, is 264,000 units, which translates into a delivery queue of four to five months from the supply chain disruption (based on our target of 600,000 units) and could drive the backlog up to nine months.

“This also provides assurances to the automakers to fast-track their production level and safeguards their margin if there is a need to increase car prices, given the increase in auto parts procurement costs,” says Wan Mustaqim in a June 21 report.

Nevertheless, the ongoing global disruption to semiconductor chips supply could stall the recovery of production for certain models, says Wan Mustaqim.

“Automakers have prioritised their usage of such resources, diverting any precious semiconductors they have to their most profitable vehicles such as full-size trucks and SUVs, as well as luxury vehicles,” he writes.

Having said that, the sector is still attractive, as it is currently trading at an “unjustified” level of discounts to the price-earnings ratio (PER), according to Wan Mustaqim. The sector is currently trading at trailing 12 times PER, which is at a 25% discount to the pre-pandemic mean of 16 times.

“We expect profit in subsequent quarters to gradually normalise to pre-pandemic levels on the back of sector earnings growth of 22% in FY2023, which should justify sector PER to gradually reverting closer to the mean,” he says.

Wan Mustaqim upgraded his call on the sector to “overweight” from “neutral” following the government’s decision to allow cars ordered before June 30 to still enjoy the SST exemption up to March 31, 2023.

Among automotive players, companies with industry leading market position and sustainable high-margin profit models are preferable, says Wan Mustaqim, who has an “outperform” call on both MBMR and BAuto, assigning target prices of RM4.10 and RM2.30 respectively.

Meanwhile, Jim Lim Khai Xhiang, an analyst with RHB Research Institute, has retained his “neutral” call on the automotive sector, premised on the multiple headwinds expected in the immediate term and in 2023.

“First, as orders may have been brought forward to June, there are concerns of softening orders in 2H2022, which may translate into soft TIV at end-4Q2022 and in 1Q2023. Second, persistently high inflation may erode consumer purchasing power, further softening demand.

“Third, inflation may pose margin compression risks. We like Sime Darby and BAuto for their ability to weather inflationary pressures — given their relatively more premium marques — and for the recovery in Sime Darby’s auto sales in China,” says Lim in a June 21 report.

RHB Research’s target price for Sime Darby is RM2.60 while for BAuto, it is RM2.

He adds that risks that may hamper the sector’s recovery include the persistent shortage of key components and delays in new model launches. Other downside risks include the tightening of bank approval criteria for car loans and a sharp weakening of the ringgit.

 

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