• The largest local player in automotive leather upholstery, with over 65% market share. PECCA is involved in the leather upholstery of passenger car seats covers (contribute ~70% to 1HFY18 revenue) for OEM, pre-delivery inspection (PDI) and replacement equipment manufacturing (REM) market segments, as well as the supply of leather cut pieces and others (contribute ~30% to revenue) to the automotive leather upholstery industry. Its main customer includes automotive seat manufacturers (Fuji Seats, Toyota Boshoku, Lear Automotive, Auto Part Manufacturers, etc.), which in turn supply car seats to automotive OEMs (Perodua, Toyota, Proton, Nissan, Honda etc.) and automotive distributors (Perodua Sales).

• HLIB maintains a BUY rating with RM1.72 TP (45.7% upside). We remain positive on PECCA amid its undemanding valuations at 11.6x FY19 P/E and 1.37x P/B (30% and 19% lower than average 16.6x P/E and 1.7x P/B since listed), supported by a commendable 12% EPS CAGR from FY17-20, net cash of RM92m or 49sen (ex-cash P/E of 6.8x), and potentially higher dividend payout (expecting 5.1%-6.8% for FY18-19 DY).

• Diversifying into the aviation leather upholstery market. In 2016, PECCA established PAviation (60% -owned subsidiary) to penetrate into aviation market (working with AirAsia and Malindo on some small scale and short-term refurbishment jobs for assessment purpose).

• A steady 2% growth of TIV in 2018. PECCA is the major beneficiary of the growing Malaysia automotive industry, driven by recovery of domestic demand and potential growth of export market (Malaysia as export hub for regional market) with Perodua, Toyota, Nissan, Honda and Proton as key clientele.

• Increasing leather program by OEMs. OEMs have been increasing their leather program over the years to boost sales volume as the competition intensified. The market share of leather car seats rose to c30% of TIV in 2017 (vs. 15% in 2013). Going forward, we expect OEMs to continue adapt higher leather program for new model introduction as the market becomes more competitive and demanding, benefiting PECCA as the Malaysia’s largest automotive leather upholstery player.

• A better 2H18. The weak performance in 1H18 was mainly due to lower than expected sales demand from Perodua, on the destocking exercise of Perodua (phase out of the old MyVi model) and followed by Perodua’s mismatch of production mix and consumer demand for the new MyVi. The demand from other major clients – Nissan and Proton also continued to be weak due to lack of new models and loss of consumer confidence.

• However, management guided for car seat sales to improve in 2H18, mainly driven by the gradual production ramp up of Perodua’s new MyVi model, which is currently constrained by some of the supplier’s ability to increase production. Sales outlook of Perodua (contributed 34.5% of Pecca revenue in FY17) looks positive in coming years with new line up of Alza facelift and new SUV planned for 2018. To recap, Perodua reported a strong market share of 40.9% YTD 2018 (with 34.8k units; +13% yoy) in Malaysia TIV sales.

• Potential downtrend reversal. In wake of a “risk off” selldown on the small caps, PECCA’s share prices tumbled 30% from YTD high of RM1.65 (9 Jan) to end at RM1.18 yesterday. However, we see potential downtrend reversal owing to the hammer candlestick formation (daily chart), supported by its steady earnings growth and undemanding valuations coupled with solid financial position. Downside is further cushioned by company’s active share buyback (bought back 2.2m treasury shares in the last six months).

• A successful breakout above RM1.19 (10d SMA) will spur prices higher towards RM1.25 (23.6% FR) and RM1.32 (38.2% FR) before reaching our LT target at RM1.45 (200d SMA). On the flip side, key supports are situated at RM1.13 (all-time low on 6 & 12 Apr) and RM1.10 zones. Failure to hold near RM1.10 may weaken share prices lower towards RM1.00 psychological levels. Cut loss at RM1.08.

Source: Hong Leong Investment Bank Research - 13 Apr 2018