Auto Sector- NAP review delayed by a month

Recommendation: OVERWEIGHT (unchanged)
- NAP review delayed by a month
* Review of the National Automotive Policy (NAP) is understood to have been delayed - according to a business weekly, citing unidentified sources. The NAP review, which was earlier scheduled to be releaseed end of this month has been postponed to November.

* Complications are understood to have stemmed from issues related to approved permits (AP). While there were calls in the past for the AP system to be reformed - due to its inconsistency with World Trade Organisation rules and other open trade policies due to restrictions brought about to international trade - abolishing the system may not be as straight forward a task.

* First, AP holders generally comprise of well connected individuals within the country - whereby APs are understood to have turned into a means to reward those who had assisted poiticians in garnering support. Second, there is the issue of compensating existing AP holders - who have invested a considerable amount into existing auto businesses.

* Back in July, Tan Sri Muhyiddin Yassin stated that the system of AP imports would be done away with and urged existing players to "buck up". However, this was the complete opposite of what was indicated in the year before - that the AP system will likely be around for the next decade.

* While it is difficult to conclude - at this point in time - whether an outright abolishment of the AP system will materialise, we think progressive measures to liberalise the local auto sector would be considered, nonetheless.

* This would lead us to conclude that measures to strengthen Proton's foothold in the auto industry are also in the works . This would include potential strategic partnerships with foreign carmakers to address issues in areas of technology, new model development, quality control, economies of scale and market outreach.

* Adding to newsflows of an imminent restructuring at Proton, it was reported in a local daily over the weekend that DRB-Hicom had submitted a bid for a 32% stake in Proton - with hopes that a more private sector driven approach will help improve the entire industry.

* While we do not rule out potential local partners taking up strategic stakes in Proton - we do not expect this to materialise any time soon in view of huge investment write-offs faced by Khazanah should it relinquish its stake at current price levels. We would rather think that any shareholding changes at the holding company level should happen post a strategic partnership - which we expect would enhance Proton's prospects - leading to improved valuation.

* We maintain our OVERWEIGHT call on the auto sector on an expected recovery in sector earnings following a projected 50% contraction in 2009. Our top picks are Proton (BUY, FV: RM4.80) - mainly on expectations of stuctural changes coming off a depressed valuation base and Tan Chong (BUY, FV: RM2.70) on expectations of a strategic expansion in model mix within the next three years starting from 2010.