Proton Lau Ya Chia still can move !!! - BUY - TP 4.50

• We lift our call on Proton to 4-STARS (Buy) from 3-STARS (Hold) with a raised 12- month target price of MYR4.50 (from MYR3.20) after reports that the company is in discussions that could lead to a strategic partnership and vehicle assembly contract with Volkswagen (VOW GY, EUR122.50, 1-STARS)


• StarBiz reported today, citing unnamed market sources, that the potential strategic partnership was unlikely to see Volkswagen taking an equity stake in Proton, with negotiations centering on platform and engine collaboration. The apparent reemergence of Volkswagen is a surprise. Proton and Volkswagen nearly entered into a strategic tie-up in 2007, only for the proposed deal to fall through at the last minute, after an extended courtship. While the real reasons for the breakdown of that deal have never been officially confirmed, political interests are believed to have been a major stumbling block, in addition to onerous financial demands from Volkswagen. However, recent comments from Proton’s management as well as Prime Minister Najib Razak have indicated a more liberal attitude toward the idea of having a foreign partner.
  
• 
  A strategic partner such as Volkswagen will be in a position to provide access to: (i) model platforms, (ii) more cost-effective R&D resources, (iii) engine and drive train technology, and (iv) markets. In particular, modern diesel engine technology will be important if Proton is to break into European markets. In return, Proton could offer its modern production facilities and be a manufacturing base for access into ASEAN and other East Asian markets. The forthcoming revamp of the National Automotive Policy, which has been delayed till next month, could have a major bearing on the outcome of the Proton-Volkswagen talks.

Investment rationale
Given Proton’s undemanding P/B valuation (0.39x FY10), the increasing investor risk appetite and dearth of other major corporate newsflow, the stock represents a strong trading opportunity. The entrance of a strategic partner on favorable terms could have a major impact on Proton’s medium-term prospects. It would reduce the valuation discount, in addition to resolving key issues, including limited product platforms, ageing models, small engine range, low R&D resources and low economies of scale from the small current production volumes. We raise our 12-month target price to MYR4.50 (from MYR3.20). We continue using a relative P/B approach to derive our target price - ascribing a target P/B multiple of 0.46x (up from 0.33x, to reflect the potential impact of a strategic alliance) to prospective CY10 BVPS (unchanged) of MYR9.69. The target P/B multiple remains at the mid-point of its five-year P/B range of 0.15x-0.96x.

Risks
Risks to our forecasts include an unexpected dip in consumer spending that could render our vehicle sales forecasts too optimistic. A sustained depreciation of the MYR against the JPY and USD would also increase import costs and crimp margins. The failure of negotiations with Volkswagen or an alliance on unfavorable terms for Proton and its shareholders could disappoint investors.