This article first appeared in The Edge Financial Daily on October 26, 2017 - November 1, 2017

Pecca Group Bhd 
(Oct 25, RM1.39)
Initiate coverage with hold and a target price (TP) of RM1.52: Pecca Group Bhd 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 rerating catalysts and trading at 17.3 times financial year 2018 estimate (FY18E) price-earnings ratio 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 to 2017 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 year-to-date 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 FY18 core earnings to grow 9.1% year-on-year 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 and as more entry-level segment cars adopt leather programmes as their basic package. 

Pecca’s net cash position currently stands at 49 sen per share, or 34% of its market cap, which is intended for potential merger and acquisition 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 five sen per share as special dividend (on top of our current five sen dividend assumption), which translates into a FY18E dividend yield of 6.8%. 

We initiate coverage with a “hold” rating and 12-month TP of RM1.52, pegged at 18 times price-earnings multiples on our FY18E earnings per share. — Affin Hwang Investment Bank Bhd, Oct 25