Post 3QFY18 briefing, we are positive on the group’s outlook. The lower margin in 3QFY18 was an exceptional case due to combination of labour shortage and exceptional demand orders, which the management has sorted out. Sales demand is expected to remain robust for upcoming 4QFY18 on Raya sales campaign and “zerorisation” of GST effective 1 Jun 2018. Management also indicated potential acquisition exercise for RM70m and assured to be value accretive to shareholders. Furthermore, management is also committed a final dividend distribution of at least 3 sen/share by 4QFY18. Maintain BUY recommendation with unchanged TP: RM1.35.

Temporary hike in direct costs. Pecca experienced lower margin in 3QFY18, affected by increase in labour costs and maintenance costs of c. RM1.0m. The group has to bear the foreign labour levy costs of RM200k/quarter starting 2018 (under government ruling) and increasing overtime time costs due to combination of shortage of experience labour, shorter working day quarter and sudden unscheduled spike in product demand by Perodua and Toyota. Management indicated its utmost priority to meet the clients’ exceptional demand orders despite the higher cost, in order to maintain its commitment and long term relationship with the clients. The possibility of passing back the higher cost is up to the clients’ goodwill. Nevertheless, management guided the situation has been sorted out on smoother planning schedule by the clients and training-up of new batch of labour and hence improving margins in coming quarters.

Weakened sales mix. Furthermore, there was RM500k impact from the weakened sales mix in 3QFY18, due to lower PDI and export REM sales (higher margin), combined with higher demand from lower margin OEM market (Perodua) and leather cut pieces (Toyota). Management expect sales mix to improve on higher PDI and export sales.

Domestic volume to sustain. Sales order from Perodua is still strong, due to high market demand for new generation Myvi (launched in Nov 2017). We expect stronger sales in upcoming 4QFY18 in tandem with Raya festive campaigns and “zerorisation” of GST effective 1 Jun 2018.

Export volume to improve. Management guided it has engaged a new exclusive distributor MITO in US and expect exports to increase, given MITO’s more active role and commitment. Demand order from Singapore is also improving in 4QFY18.

Potential M&A. Management has identified a number of target acquisitions (related to automotive business) and is expected to make announcement soon subject to further due diligence. The expected acquisition price is c. RM70m, which will be financed by the group’s cash coffer of RM90.3m. Management assured that the acquisition would be value accretive to shareholders.

Stable dividend. Management is committed to distribute dividend for FY18 at least similar quantum in FY17, which was 5 sen/share, indicating further final dividend of 3 sen/share by 4QFY18 (Pecca has distributed interim dividend of 2 sen/share in 2QFY18).

Forecast. Unchanged.

Maintain BUY, TP: RM1.35. We maintain our BUY recommendation on Pecca strong operating cash flow of RM16-20m per annum (for FY18-20) on top of its current net cash position of RM90.3m (translating into 48 sen/share).

Source: Hong Leong Investment Bank Research - 28 May 2018