We like Pecca (listed in April 2016 at RM1.42) due to its dominant position (over 60% market share) in the automotive leather upholstery segment with ~20% for exports. Pecca’s 55% meltdown in share price YTD is irrational and has made it an attractive value proposition as earnings recovery is set to normalise, supported by a strong FY18-21 EPS CAGR of 23%, cheap valuations at 8.9x FY19 P/E and 0.81x P/B (45% and 43% lower than average 16.1x P/E and 1.4x P/B since listed), solid net cash of 49.6sen per share (ex-cash P/E of 2.6x) and strong DY of 8.5-14.2% for FY19-21. Further rerating catalysts include the value accretive M&A and pending the DCA approval for leather seat covers supply contract for commercial aircraft.

Domestic volume to grow. Sales order from Perodua is still going strong especially for the Myvi model. Management expects further efficiency gain from the model, which will improve margin in coming quarters. New anticipated models include the new Perodua SUV in 4Q18.

Export volume to improve. Export volume to Singapore and US are expected to recover in FY19 after weak sales flow in FY18, being dragged by Singapore’s stricter vehicle emission scheme and change in US distribution channel. The volume increase will improve overall group margin, given that export prices are c.30% higher than local prices.

Potential M&A. Management is targeting an M&A exercise (related to automotive industry) by end 2019, pending further due diligence. Its cash coffers of RM91m would be sufficient to finance the M&A exercise. Management assured that the acquisition would be value accretive to shareholders.

Aviation. Management also revealed an update on its aviation business pending the approval from the Department of Civil Aviation (DCA) in granting the POA (Production Organisation Approval), which will enable PAviation to officially commence the lucrative commercial aviation refurbishment contracts.

Attractive dividend. Given the company’s strong free cash flow of RM13m (6.9 sen/share). Even with the upcoming targeted M&A exercise, management is expecting higher dividend in upcoming financial years on stronger earnings expectations and strong free cash flow.

Values resurface amid steeply oversold position. In the short term, PECCA may trap in consolidation mode as share prices continue to hover below the downtrend line and multiple key SMAs. However, downside risks are limited owing to undemanding valuations and attractive dividend yields coupled with deeply oversold slow stochastic and RSI. However, once this pattern ends, we expect prices to stage a breakout above the downtrend line near RM0.74, followed by the RM0.80 psychological barrier, before reaching our LT objective at RM0.87 (50% FR). Key supports are RM0.66- 0.69. Cut loss at RM0.64.

Source: Hong Leong Investment Bank Research - 1 Nov 2018