Solid Automotive Berhad: Strategic Asset Disposal and the Path to ROCE Sustainability

Solid Automotive Berhad (KLSE:SOLID) has positioned itself as a compelling case study in Southeast Asia's automotive supply chain sector. Its recent disposal of a factory to a related party, PAM Machinery Components, offers a lens to assess how capital reallocation decisions impact the company's Return on Capital Employed (ROCE)—a key metric for evaluating operational efficiency and capital allocation prowess.

The Transaction: A Strategic Move or a Governance Concern?

On May 16, 2025, SAB announced the sale of a 612.61-square-meter factory in Selangor to PAM Machinery Components for RM6.28 million. The transaction is classified as a related party deal due to the interests of SAB's directors and major shareholders in PAM. While the immediate financial implications are clear—reducing capital employed by shrinking total assets—the broader strategic rationale is less transparent.

The factory in question was part of Win Soon Auto Suppliers, a wholly-owned subsidiary. SAB's rationale hinges on strategic portfolio optimization, with the company citing a focus on core automotive operations. However, the involvement of a related party raises questions about valuation fairness and potential conflicts of interest. Investors must scrutinize whether the sale price reflects market rates or if minority shareholders are being sidelined.

ROCE: A Beacon of Efficiency, Now in Flux

SAB's ROCE has been a standout performer. As of July 2024, its ROCE stood at 16%, nearly tripling the 6% average for retail distributors in Malaysia. This outperformance stems from disciplined capital management: over five years, capital employed grew by 45%, while ROCE rose sharply, suggesting reinvestment at increasingly efficient rates.

The recent disposal could further boost ROCE in the short term. Selling non-core assets reduces the denominator (capital employed) while potentially preserving EBIT (if the factory was low-margin). However, long-term sustainability hinges on how proceeds are redeployed. If the capital is used to fund high-ROIC projects—such as automation upgrades or new market entries—the trend could endure. Conversely, poor reinvestment could erode gains.

Risks Lurking in the Shadows

Two critical risks temper optimism:
1. Governance Perception: Related party transactions, even if procedurally compliant, can erode investor trust. If PAM's ties to SAB's management are perceived as favoring insiders, it could deter institutional capital.
2. Earnings Volatility: The factory's contribution to EBIT is unclear. If it generated material profits, the disposal could depress near-term earnings, offsetting ROCE gains.

Investment Thesis: A Compounding Story with Caveats

SAB's ROCE trajectory aligns with the traits of a compounding machine—reinvesting capital at high returns. The stock's 17% underperformance over five years, despite strong fundamentals, suggests a valuation discount tied to governance concerns or market skepticism about the company's strategic clarity.

Buy Signal: Investors with a long-term horizon and tolerance for governance scrutiny may find value here. A ROCE of 16% vs. a 6% industry norm implies a 10%+ earnings growth edge over peers. If management uses the disposal proceeds to fuel margin expansion (e.g., through automation or premium product lines), the stock could re-rate sharply.

Hold/Proceed with Caution: Until transparency on the transaction's valuation and governance safeguards improves, the stock remains risky. The two unidentified warning signs—possibly balance sheet strains or competitive threats—demand further diligence.

Conclusion: A Strategic Crossroads

Solid Automotive Berhad's disposal of the PAM-linked factory is a pivotal moment. If the move crystallizes capital for high-return ventures, ROCE could climb further, rewarding patient investors. However, without clarity on governance and post-disposal strategy, the stock remains a speculative play. For now, wait for clarity on reinvestment plans before committing capital—or consider a small position as a bet on Malaysia's automotive supply chain recovery.

Investment advice: SAB's stock offers asymmetric upside if ROCE trends hold, but prioritize due diligence on related party terms and post-sale strategy.