On the back of i) higher penetration of automotive LEDs in the auto market, ii) increasing capacity production, and iii) improving margins, we remain upbeat on D&O Green Technologies (D&O) as it is well-positioned for another record performance this year. Management has indicated that this is just the beginning of an explosive growth momentum over the next 5 years. In view of its increasing market share in the global automotive LED market and leading position in the smart LED development, we raise our TP from RM5.91 to RM6.31, pegged to a higher PER multiple of 48x (previously 45x) FY22 EPS. Maintain Outperform call for its multi-year earnings growth prospects.
- Catching up on loss of production. Despite news of global vehicle production cuts hogging the limelight recently, management is more concerned about the occasional production disruption due to the Covid-19 spread. The production plant in Melaka encountered two rounds of shutdown over the last two months, resulting in a total of 25 days of closure. As most of its workers are now fully vaccinated, it has been running at nearly full capacity to resolve the bottleneck.
- Plan for third production plant finalised. The existing production plant with a floor space of 16k sq meter, literally known as Plant 1, is expected to be fully occupied by early-2022. The second production plant (Plant A), which has a bigger floor space of 25k sq meter, has already started the smart RGB LED production on a small-scale basis before seeing mass production take place in mid-2022. It has also started transferring the technical and technology to the second plant for the conventional LED production in the future. Based on its forecast, the second plant could hit full capacity as early as 2024-2025 as its German end-customer will roll out a series of new car launches (i20, 7 series, 5 series, 3 series) in the next 4 years. It is worth noting that as smart RGB LED is more applicable for top end car models, the average selling price is significantly higher compared to conventional automotive LEDs. Meanwhile, the masterplan for the third plant (Plant B) is in the final stage, with construction being kick-started by early-2022. The 8-storey building will have a total floor space of 30k sq meter, which is nearly double the size of the Plant 1. Management has set aside an initial capex of RM200m for the Plant B.
- Booming electric vehicle (EV) sales will push higher demand for LED. According to TrendForce forecast, the LED penetration rate for global passenger cars reached 53.1% in 2020 and is expected to hit 60% in this year. Meanwhile, the LED penetration for electric cars was significantly higher, standing at 85% in 2020 and is expected to hit 90% this year. We also understand that some of the EV car models have adopted more than 4,000 LEDs/car, a massive increase compared to only less than 1,000 LEDs for the conventional car models. We believe the higher adoption of automotive LED coupled with the structural shift from combustion engine to electric battery will bring multiple growth for the automotive LED makers in the next 5 years.
- Robust outlook. Driven by seasonally strong demand towards year-end, we expect 2H to contribute about 55%-60% of our full-year earnings forecast. In anticipation of a stronger orderbook until early-2022 and to avoid logistic issues, the Group increased its raw materials purchase by more than 29% over the last 6 months. Meanwhile, the third round of capacity expansion that took place last month is timely to capture the higher sales order in the coming months. Based on our analysis, the new capacity could increase its monthly sales volume by about 45% compared to the first half of the year. It is understood that management has doubled its committed capex this year to RM100m, which is about 10% of our estimated full-year revenue. About 50% or RM65.7m has already been spent in the 1H in preparation for the business wins that have been secured. Meanwhile, for the first 7 months, the company has received a 15% YoY increase in design-in enquiries.
- More room for margin improvement. As more than 70% of the existing machines (die casting machines) are slowly being converted into triple deck (under development stage), there will be more room for margin improvements in the near-term as more automation will be in place. This not only increases the space utilization as more capacity is added within the same production floor, it also helps expand margins. We understand that the production can potentially hit full capacity utilisation based on 60% headcounts as automation helps ease the workloads. This can be seen when the gross margin rose from 28% over the last two years to more than 30% this year. Based on our sensitivity analysis, every RM30m increase in monthly sales, it could potentially bump up its margins by about 1%-2%
- No luck with Syntronixs Asia S/B. The proposed acquisition of Syntronixs Asia had been called off yesterday partly due to non-satisfaction of certain conditions that are required by D&O as per the terms of the offer. Nevertheless, the company will remain committed to invest into its own electroplating lines and moulding facilities for leadframe in the near-term as they are part of the crucial supply chain for its automotive LED solutions. At the present, it has installed 2-3 electroplating lines for the smart LED manufacturing process. Without the acquisition of Syntronixs Asia S/B, it has less concern in filling up the huge number of electroplating production lines, which are highly concentrated on few key customers
Source: PublicInvest Research - 10 Sept 2021