Pecca Group is an established automotive leather upholstery player in Malaysia with a leading 68% market share. In our view, Pecca is poised to benefit from the gradual recovery in the automotive segment and see its breakthrough in the aviation venture as a longer term catalyst. However, lacking any near-term re-rating catalyst and trading at 17.3x FY18E PER with a dividend yield of 3.4%, we believe current valuation appears fair. Hence, we initiate coverage on the stock with a HOLD call and 12-month TP of RM1.52.

A Good Proxy to Improving Auto Sales

While growth has been lacklustre over 2016-17 due to weak automotive industry sales, the increasing proportion of cars fitted with leather upholstery (especially in the A and B segments) is a growth catalyst. Market share for Malaysian cars has been on an upward trend, increasing from 46.7% in 2014 to 48.8% in ytd-2017.

Next Catalyst for Growth From Aviation

Aside from the automotive segment, we see growth catalysts coming from its penetration into the aviation segment, where it plans to secure long-term contracts to supply seat cover replacements. Despite having been appointed a vendor by a couple of airline companies and private jet charter firms, it is only doing small-scale refurbishment jobs for private jets for now.

Boosted by Additional Capacity and Lower Raw-material Prices

We forecast Pecca’s FY18E core earnings to grow 9.1% yoy driven by: i) an additional 50,000 set capacity expansion, ii) slightly better margins from expected lower raw-material prices, and iii) increasing leather programmes by car manufacturers moving forward. We believe that Pecca leather car seat sales will improve in the coming years, in line with our view of a longer-term recovery in total industry volumes (TIV) and as more entry level segment cars adopt leather programmes as their basic package.

Initiate With a HOLD and RM1.52 Target Price

Pecca’s net cash position currently stands at 49sen/share, or 34% of its market cap, which is intended for potential M&A prospects. However, in the event this does not materialise, Pecca could potentially reward shareholders with higher dividends. Based on our estimates, Pecca could easily pay out an additional 5sen/share as special dividend (on top of our current 5sen dividend assumption), which translates to a FY18E dividend yield of 6.8%. We initiate coverage with a HOLD rating and 12-month TP of RM1.52, pegged to 18x PE multiple on our FY18E EPS.

Source: Affin Hwang Research - 25 Oct 2017