Investment Highlights

• We initiate coverage on Pecca Group (Pecca) with a BUY and fair value of RM1.80/share based on an FY19F PE of 16x. We believe that a PE of 16x—the higher end of the range for the automotive parts sector — is justified given the group's strong market position compared to its peers as well as its clear and convincing growth plans.

• We highlight the following key investment merits:

1) Topline to ride on TIV recovery, anchored to its relationship with Perodua. Perodua is the dominant player in the domestic market (with a market share of 38%) and poised to benefit from the appetite for cheap sedans and SUVs in the coming years.

2) Unlocking the potential for growth in the long term will diversify its earnings from the automotive segment and the domestic market. Strong business performance in Southeast Asia is expected to continue boosting exports (which made up 20% of revenue in FY17), while the aviation segment will start to contribute upon securing a maiden contract within the coming years.

3) Pecca would benefit from a strengthening of the ringgit as nearly 40% of its costs are in USD, from the purchase of leather hides. We note that the group's margins have weathered both the weakness in the ringgit and a decline in sales: FY17 gross margin of 27% and net margin of 12% are in a far better shape than the single-digit margins OEMs have dwindled to.

4) Financials are in a clean slate following the IPO in early 2016. Pecca's financial standing is healthy with a net cash of RM93mil and zero borrowings. It has set aside RM13mil for what would be its biggest capex item in the immediate future: the purchase of new machines and expansion of its existing plant.

• While the group sits on what we believe to be a fortified position within a recovering automotive industry, the key risks going forward are as follows:

1) The utilization rate of its Kepong plant could fall from the impressive 75% seen currently, to around 60% following the addition of 50K car sets/annually in capacity by end-2017. Sales recovery and a pipeline of new models from its key clients (notably Perodua and Toyota) would serve to boost utilisation, as well as better numbers from exports.

2) Its dependence on underperforming OEMs (namely Nissan and Proton, which together account for 18% of car seats sold) could turn out to be a palpable drag in the short term.

Source: AmInvest Research - 4 Oct 2017