We hosted a virtual meeting for D&O Green Technologies (D&O) last week, with several key highlights shared by management. As more automakers start picking up D&O’s smart LED applications, management is now targeting about 100m pieces of smart LED sales in 2023. To meet the increasing automotive LED demand, the Group is planning another double-digit capacity growth for FY23. Overall, we maintain our Outperform call with an unchanged TP of RM5.16 based on 35x FY23 EPS.

• Global car sales outlook. According to LMC Automotive, global car sales in 2023 is set to remain below pre-pandemic levels for a fourth year. Deliveries are expected to stay at 81.5m vehicles (refer to Figure 1) compared to 90m deliveries in 2019 as consumers turn cautious amid inflationary pressures and interest rate surge. Global vehicle sales are set to take until 2024 to recover to pre-pandemic levels. Meanwhile, global battery electric vehicle (BEV) sales are projected to surpass 10m units this year, making up 12.2% of global car sales. It is expected to see another strong double-digit growth next year before reaching 20m in 2024.

• China car glut builds as production outstrip sales. Carmakers are making efforts to reduce a glut of unsold units in a slowing economy, as factories are filling passenger vehicles in showrooms faster than distributors can sell them. In September, car deliveries rose by 33% while retail sales climbed only 9%, a trend that could pose a risk of overhang, which can weigh on auto sales in subsequent months. China will need to start easing movement restrictions soonest possible before it can pare down the oversupply to an optimal level. On a positive note, domestic car sales are anticipated to see a strong pick-up towards year-end as car dealers sprint to fulfil sales targets while customers also rush to buy cars before government subsidies for electric vehicles and tax cut for small engine vehicles expire. In more recent developments, we understand that inventories are rapidly drawing down as numerous cities in China have announced easing of coronavirus curbs over the weekend after unprecedented protests against restrictions a week ago.

• Smart LED sales picking up. Management is eyeing 100m pieces of smart LED sales in 2023, a staggering growth of almost 4x compared to 2022 as demand from China and South Korea starts to pick up. Based on our estimates, smart LED sales are likely to contribute at least 7% to group sales in FY23, up significantly from 1-2% this year. Generally, smart LED fetches higher margin than conventional LED (ASP is 10x higher than conventional LED) though it still needs to depend on the margin as a whole as 80% of smart LED and conventional LED products share the common manufacturing platform. Some notable car brand names that have started adopting the smart LED applications in their selected models include BMW, HongQi, Kia and Geely.

• Design-in participation remains active. Despite seeing slowdowns in the global economy, the company’s participation in design-in (initial success where customers consider the design of Dominant products) remains steady, led by active enquires from China, Europe and US. Meanwhile, the Group has planned an aggressive annual capital expenditure (capex) of RM170m-RM180m (10%-15% of annual turnover) for 2023-2025 to meet customer demand. That almost equals the company’s estimated annual operating cash flows. For the first 9 months, the Group had spent RM156.5m on capacity expansion and renovation works for Plant 2. Production capacity is expected to grow by 38% this year followed by another 28% in 2023. Following the freeing up of office space in Plant 1, we now expect it to generate up to RM1.2bn in annual turnover. Meanwhile, renovation works for Plant 2 is almost complete with the clean-up set up and commercial production expected to kick start by end- 1QFY23 with the first smart LED module to be installed in view of the strong demand. It also requires more time on the technical know-how given the complexity of the chip and LED combination. Based on its quantity forecast from its end-customers, plant 2 is expected to be fully utilized by 2025-2026.

• Expecting flattish growth for 4QFY22. Despite the production capacity expansion, we think growth could be flattish for the final quarter as the company plans to adopt production optimisation due to overstocked position by customers in China given the recent overhang situation, which is expected to be normalized by early-2023. 4QFY22 margins are likely to drop by 1%-2% due to lower utilization rate and the impact of higher minimum wage this year. Meanwhile, the exposure to unrealized foreign exchange losses in 4QFY22 is expected to be largely muted as the Group has almost hedged the entire USD borrowing position with USD deposits.

• Moving into era of 12”-30” large display panel. Management also sees the technological shift of the automotive displays, which are generally based on thin-film-transistors (LCD), from Edge-Lit display to Direct-Lit displays starting from 2H 2023 as the traditional Edge-Lit technology is no longer applicable in big screens. The Direct-Lit display panel not only achieves greater contrast ratios (on par with OLED performance) and maintains high peak illumination, it is also more cost effective and requires less power consumption as the LEDs are not lit unless needed. The LED consumption per car is projected to surge by 8x-10x under the local dimming backlight technology for Direct-Lit, where the LEDs are directly behind the LCD panels. Based on Mercedes-Benz’s EQS model forecast, the direct-lit display segment could potentially fetch a market size of 50bn pieces of LED worth a whopping USD1bn annual sales in 2025-2026. We understand that D&O’s Dominant is currently one of the leading players for the direct-lit display’s Bevel-LED development and it is set to seize the market opportunities when the application commercializes. Management shared that they have already secured some orders for Direct-Lit display panel and the prototype is expected to be ready by year-end with mass production taking place 2H next year.

• Update on smart LED chip design. To mitigate the risk of high dependency on its chip supply for smart LED products, the Group has embarked on its own chip design and plans to commercialise in 2025. Management witnessed the first-of-its-kind physical chip, which has the functionality of analog, digital and memory, in the recent trip to Taiwan and expects the finished product to be ready by June 2023. After that, it is required to go through a series of testing, stringent reliability tests and design-in phase with end-customers for the next 2 years.

• Looking at another double-digit growth. After seeing a strong topline growth for the first 9 months of this year, management is conservatively targeting 15% growth for 2023 with gross margin expected to normalize to 30%-31%.

Source: PublicInvest Research - 5 Dec 2022