RCE Capital a wholly-owned subsidiary of AMCORP and its primary business is involved in personal financing via salary deductions from civil servants. Both its net earnings margins and financing growth have been seeing double-digit since 2015. Although we are projecting a conservative FY17E-FY18E earnings forecasts of RM45.6m (+15.2%) - RM49.8m (+9.3%), we find the stock undervalued and recommend a TRADING BUY with a Target Price of RM1.50 (+14% upside) based on a 10.0x FY18E PER.

RCE Capital Berhad (RCECAP) is a wholly-owned subsidiary of AMCORP via Cempaka Empayar Sdn. Bhd. with the ultimate shareholder being Tan Sri Azman Hashim with a 63.1% stake in the group via Cempaka Empayar. Currently, its main operations are personal financing (core business), collection management and commercial financing. Personal financing business is catered to public sector employees only via salary deduction.

A simple business model; loans are channelled via its subsidiary RCE Marketing Sdn Bhd which are then disbursed to various Co-Operatives & Foundations which in turn lend to their end-borrowers (government employees) via personal loan scheme with direct salary deduction. Salary deduction collections are made via Angkasa (Angkatan Koperasi Kebangsaan Malaysia) and RCECAP’s wholly owned subsidiary EXP Payment Sdn. Bhd., which provides an alternative solution as a centralized collections agency.

Funding issue addressed with longer-term debts. Funding for its loans is via the debt capital market which since 2007 have been addressed with longer tenure debts. In June 2016, RCECAP issued a 10-year Sukuk (a multiple-tranche issue) of RM900m with a tenure of 10 years (as personal financing has been limited to 10 years) and a semi-annual payment of 5%-7% (for Tranche 1). Tranche 1 consists of RM156m with Tranche 2 (RM181m) expected to be issued by Oct 2016.

Spectacular profitability. Average net earnings margins of 22% (2012-2016) on the back of high NIMs of 9% and low CIR of 22%. However, earnings CAGR (2012-2016) has been in negative territory (-21%) due to high credit charge ratio (average 12%) and declining financing growth from 2012-2014 (- 9%/-6%/-1%) attributed to temporary ceasing of disbursement of loans from one of its borrowers and tighter restriction of borrowings imposed by Bank Negara Malaysia (BNM) on personal financing. Since 2015, financing growth has returned back in mid-teens (with credit charge averaging 7.5%) translated into a 3-year earnings CAGR of almost 60%, as competitors shifting focus from personal financing coupled with RCECAP’s marketing flexibility & fast approval, which saw loans growing by double digits for FY15/FY16 (+15%/+17%).

TRADING BUY; Target Price of RM1.50. We are projecting RM45.4m/RM49.3m net profits for FY17E/FY18E with key earnings assumptions being; (i) three-year loans CAGR of 12% anchored by a ceiling limit of loans at 4X total equity (or 25% of CAR of AEONCR) which theoretically speaking allows RCE to take up loan of up to RM1.8bn (vs RM1.26bn in FY16), (ii) NIMs of 8.5%/8.4% (FY16: 8.9%), (iii) CIR of 23%/22% (FY16: 24%), and (iv) credit charge of 7% for both FY17/FY18 (vs. FY16: 8%). Even conservative in our forecasts, we believe its valuation is still cheap. The stock is traded at 9.0x/8.2x to FY17E/FY18E EPS. Besides, assuming a 40% pay-out ratio, the stock will generate 4.1%/4.5% dividend yield for FY17E/FY18E. As the ROE is expected to improve from <8% in FY13-FY16 to ~10% in the next 2-3 years, we believe the stock should be rerated. Pegging to a 10x PER against FY18E EPS, the stock should be valued at RM1.50 vs. current price of RM1.33 (3%-13% upside) and consensus target price of RM1.60.

Source: Kenanga Research - 4 Oct 2016