Mainstream
Mounting pressure to turn around Proton
Khairul Khalid 
Nobody is expecting an instant turnaround, with DRB-Hicom targeting to bring Proton into the black in five years with Geely, says an automotive executive
advertisement[x]

Although it’s still too early to judge DRB-Hicom Bhd’s move to tie up its flagship Proton with China’s Zhejiang Geely Holdings Group Co Ltd, the pressure to turn the ailing national carmaker around will soon mount.

DRB-Hicom posted a RM736.56 mil net profit in the second quarter ended Sept 30, only its second profitable quarter in the last eight, but that is largely due to the RM1.1 bil research and development grant that Proton received from the government in October.

An automotive executive tells FocusM Proton’s stronger sales is a good start, but the fact that it is still far from breaking even means that the Proton-Geely joint venture will be under increasing scrutiny beginning next year.

“Proton is still losing money, despite the new models doing well. Nobody is expecting an instant turnaround, with DRB-Hicom targeting to bring Proton into the black in five years with Geely. All eyes will be on them beginning next year, especially with the anticipated launch of a new model at the end of next year.

“I am expecting three years as a reasonable time for it to turn around if it can address some of the critical issues such as streamlining local vendors. This will give them time to develop opportunities in other foreign markets.

“Nevertheless, the China market is experiencing a slowdown, so Proton might take a bit of time to recover,” says the industry player.

Improved sales in the second quarter were far from enough to drag Proton out of the red just yet.


Sharing the burden

Improved sales in the second quarter were far from enough to drag Proton out of the red just yet.

According to a RHB Research Institute report, Proton recorded sales of 36,921 units during the period, This was 19.6% higher year-on-year (yoy), but was estimated to represent only two-thirds of the volume required to break even.

As of Nov 30, Proton sold 66,190 units, registering a modest 2% growth mainly driven by its Saga and Persona models.

Contributions from DRB-Hicom’s 34%-owned Honda Malaysia were higher, owing to record Honda sales, which improved 11% yoy.

“The proceeds from the R&D grant and sale of Lotus would help to cut borrowings and ease financing costs. From the next quarter, Geely is likely to help share the burden of the ongoing operating losses at Proton, which we expect would continue until it can offer new products and improve brand perception,” says RHB Research.

It expects DRB-Hicom to turn around in subsequent quarters after the completion of partial divestment of Proton and disposal of Lotus in Q2FY18.

DRB’s automotive division reported a slight increase in revenue by 1.6% yoy to RM1.9 bil due to higher sales volume (+17.7% yoy) by Proton’s new Saga and Persona.

“We expect its automotive division to improve going forward, anchored by lower losses recognised from Proton upon completion of the disposal of a 49.9% stake in Proton to Geely, which is expected to be completed by Q4FY18,” says Public Investment Bank in its report.

Excluding the grant received by Proton in Q2, DRB-Hicom’s automotive division’s pre-tax loss increased to RM277.4 mil (versus RM166 mil in Q2FY17) due to lower sales volume from Isuzu (-13.6%) and Mitsubishi (-32.5%).

The segment was partially cushioned by the contribution from associates (+11.9% yoy) due to better sales from Honda (+11% yoy).

Minus the grant, the carmaker posted an operating loss of RM330 mil for Q2 and a H1 loss of RM501 mil. The company also incurred restructuring costs and a loss from the sale of Lotus totalling RM155.6 mil.

 

Geely catalyst

The grant was released by the government after Proton fulfilled its condition of securing a strategic foreign investor to make it more viable and competitive.

Some analysts are optimistic that Geely’s expertise and track record will be strong factors in its partnership with Proton and lead to an eventual turnaround in the latter’s fortunes.

A report by Hong Leong Investment Bank (HLIB) says with the completion of the divestment exercises, DRB-Hicom is expected to revert to positive earnings from Q3FY18, as it only needs to recognise 50.1% of Proton’s huge financial loss while disassociating from Lotus’ loss.

“With the emergence of Geely as strategic foreign shareholder of Proton, we can expect a re-rating catalyst on DRB’s valuation,” says HLIB.

Honda Malaysia also continues to lead the foreign car market segment with new models, including the new BRV, Jazz facelift and hybrid, City facelift and hybrid, and new CRV launched during the year.

However, HLIB cautions that prolonged bank tightening on lending rules, a slowdown of the Malaysian economy affecting car sales, global automotive supply chain disruption as well as slow integration of Proton and Pos Malaysia are potential risks to DRB-Hicom.

 

Declining trend

In June, Geely acquired a 49.9% stake in the national car manufacturer for RM460.3 mil, of which RM170 mil was paid in cash and the remaining RM290 mil was a transfer of Geely’s Boyue sports utility vehicle (SUV) platform to Proton, which is expected to be used as a base for Proton’s first-ever SUV.

Acquiring a strategic partner was one of the conditions imposed by the government for extending a RM1.5 bil soft loan to the national carmaker.

Proton’s market share of passenger cars was 14%, or 72,290 units, last year, down from 17.3% or 102,175 units in 2015.

Perodua was the market leader with a 40.3 % share or 207,110 vehicles sold last year, followed by Honda with 17.8% or 91,830 vehicles.

Proton’s partnership with Geely is seen as crucial not just to improve its earnings, but also to provide it with access to foreign markets.

A Geely partnership due to its international presence via Volvo, could offer Proton more avenues to expand its business in countries such as the UK, India and Australia. In return, it could also give the Chinese firm a significant entry into the global market for right-hand drive cars.

Proton’s export sales have been on a declining trend. It exported 16,189 units in 2011, 13,311 in 2012 and only 5,937 in 2013. Since then, it has reportedly averaged around 5,000 units in exports annually, or about 5% of total sales. Proton has been a drag on the earnings of parent DRB-Hicom. In its financial year 2016, Proton posted a net loss of RM991.9 mil.

Although the Geely brand is relatively unknown beyond China, the company already has an international marque, Volvo,  in its portfolio. It bought Volvo Cars in 2010 from Ford Motor Co for US$1.5 bil in cash and debt, the biggest 100% acquisition of a foreign carmaker by a Chinese firm.

Although many industry observers were sceptical of the deal, Geely has managed to turn around Volvo’s faltering fortunes.

In 2009, Volvo posted a revenue of US$12.4 bil but recorded a pre-tax loss of US$653 mil. In 2015, the company posted an operating profit of US$776.6 mil.



This article first appeared in Focus Malaysia Issue 262.