We upgrade Pecca to HOLD (from Sell) with an unchanged 12-month price target of RM1.10. Although Pecca’s share price has corrected by 13% since it announced disappointing 4QFY19 results, its revenue base looks modest, and a dip in margins and EPS will likely limit any bullish sentiment towards Pecca in the near term. At 13x FY20E PER, Pecca now trades close to the stock’s average 2-year forward PER, which looks to be fair, reflecting Pecca’s softer earnings projections.

Modest Top-line Growth on Higher OEM Contribution

Pecca’s largest revenue contributor, the Original Equipment Manufacturer (OEM) segment should remain healthy, underpinned by the strong demand from Perodua (55% of Pecca FY19 revenue). To reduce its reliance on the local OEM customers, Pecca is keen to grow the Replacement Equipment Manufacturer (REM) segment by expanding its export geographical reach. It could be a year of two halves for the Pre-Delivery Inspection (PDI) segment - Nissan’s softer car sales in the near term could soften its contribution in 1HFY20; followed by better times in 2HFY20 on possible launch of new Nissan models. Lastly contributions from the leather cut pieces may wane in the coming months.

We Expect EBITDA Margins to Moderate in FY20

Pecca’s quarterly EBITDA margins have shown signs of exhaustion since the 2QFY19 peak and we think this trend will likely persist into FY20-22E, considering the: (i) low-margin sales mix (lower ASP and higher contribution from OEM segment), (ii) higher cost environment (higher wages), and (iii) sustained weakness in the Ringgit (vs. US$). We think the cheaper leather hide prices, reduced contribution from lowermargin leather cut supply, higher REM sales and better production efficiency may not be sufficient to mitigate the margin squeeze.

Upgrade to HOLD Following Share-price Decline

Pecca’s share price has fallen by c.13%, following the release of its weak 4QFY19 results. At 13.2x FY20E PER/5% yield, we believe these negatives are priced in and valuations look fair. Upgrade to HOLD (from Sell) with unchanged price target of RM1.10 based on unchanged 13x FY20E PER target multiple.

Source: Affin Hwang Research - 25 Sept 2019