INVESTMENT MERIT

We rate PECCA with a fair value of RM1.25 based on the following key takeaways: (i) reducing single-market risk through international expansion, and (ii) growth potential from M&A and aviation segment, We believe our valuation is justifiable at 13x PER on FY20 earnings which is in-line with Auto peers. Dividend yield could be attractive at c.5% with pay-out estimate at 55%.

Reducing single-market risk through international expansion. As a leading automotive leather upholstery player in Malaysia, the group’s financial performance is positively correlated to the local automotive market as highlighted by its net profit declining from RM14.5m in FY16 to RM10.2m (-30%) in FY18 when Malaysia’s automotive Total Industry Volume declined to 576.6k units (-13%). Acknowledging the need to diversify, it is currently involved in on-going negotiations with potential strategic partners to penetrate new markets such as U.S, Australia and China. Such a move will be viewed positively as the export markets tend to enjoy better margins (double digits) compared to the local market. For example, in FY19, the group’s net margin hit a record high of 12.5% (+3.4ppt, YoY) on the back of the recovery in its Singapore market. On a positive note, the group has recently secured a contract with Subaru in China.

Potential growth areas from M&A… Given the opportunities available in South-East Asian countries, the group is also looking to accelerate its growth through M&A activities in complementary businesses. This will be funded via a combination of debt and its cash pile (of RM98.2m as of 1QFY20). Meanwhile, M&A plans are to be concluded earliest by 1HFY20, if any.

…and its aviation segment through its 60%-owned subsidiary Pecca Aviation Leather Services (PAviation). We believe this segment is attractive as the aircraft seat upholstery market is projected to grow to USD1.8b by 2025, at a CAGR of 7.3%. (Source: Markets and Markets). At this juncture, the group is pending certification from the European Aviation Safety Association (EASA), which is expected to materialise earliest by end of FY20. As such, we believe any earnings impact can only be seen in the longer term as its current contribution is minimal (<1% of group revenue).

Margin pressures labour cost issue. We observed that the group’s GP margin was hit in 3QFY18 at 21.7% (-2.9ppt, QoQ) and in 4QFY19 at 26.3%(-4.3ppt, QoQ) due to higher levy and overtime costs incurred for its workforce (to meet production deadlines). Although the group intends to automate its production going forward, we believe margins will continued to be depressed in the near term as its existing operational processes are labour intensive with a crew of 350 (representing 70% of total group headcount) to run the plants at an utilisation rate of 80% (with an output of 160-170k seats/year). Nevertheless, the group is currently focusing on securing better pricing in the domestic market to enhance margins, as evident in its OEM segment’s ASP which has improved to c.RM940/seat in FY19 (+6.8%YoY).

Overall we are positive on the group’s direction with FY20E/FY21E earnings of RM18.3m/RM19.4m on the back of GP margins of 30%. Meanwhile, our forecast revenues are closely in-line with MAA TIV sales forecasts. Note that our assumption has yet to factor in any contributions from M&A and growth from its aviation segment.

Dividends could be attractive, as we gather that the group has a minimum pay-out policy of 40%. We, however, has forecasted a pay-out at 55%, which is lower than FY19’s 60% as the company may want to conserve some cash for possible M&A activity. This translates to dividend per share of 5.2 sen/5.5 sen and yields of 4.4%/4.6%.

Fair value of RM1.25. Our ascribed TP is based on a targeted PER of 13x (in-line with Auto peers) on FY20E EPS of 9.5 sen. We believe the stock is fairly valued at current level following its remarkable rally (with 62% YTD gain) on the back of its strong FY19 results. In addition, we believe its potential new growth drivers such as: (i) regional expansion, (ii) M&A, and (iii) its aviation segment could require more time to bear fruits.

Source: Kenanga Research - 17 Dec 2019