During a recent virtual meeting with D&O, management believed that it had hit the rock bottom after seeing poor results for 1QFY23. The priority now is to improve the production yield in a cost-efficient manner as capacity is being underutilized. Management believes margins will normalize by 4QFY2023. On a more cheerful note, China has launched a six-month campaign to boost car purchases and promote electric vehicle (EV) adoption in more than 11,000 counties and villages around the country. It will definitely be a big boost to D&O as it derives about 45% of sales from the China market. Maintain Outperform with an unchanged TP of RM4.37 based on 35x FY24 EPS.

• The worst is over. Management sees a gradual recovery from this quarter onwards following the challenging financial performance in the first quarter as China’s car sales has started to pick up strongly. To recap, its display panel (backlight unit) sales volume suffered a dip in demand due to inventory overhang. Meanwhile, capacity utilization is expected to rise from 65% in 1QFY23 to 70%-75% in 2QFY23. Management is also trying to optimize its cost structure especially its labour and material costs such as wafer, leadframe, carrier tape and silicone. Due to the current ample capacity, any capacity expansion plan will be pushed back to August.

• China set to extend NEV tax incentives. A week ago, various news reports cited that China is poised to extend incentives for EV purchases as part of broader efforts to drive the sluggish New Electric Vehicle (NEV) sales following a State Council meeting chaired by Premier Li Qiang. An extension is being considered for low-or zero-emission cars for another four years. One of the measures may entail extending the purchase tax break for EVs and plug-in hybrids that cost less than 300,000 yuan (USD42,400). To recap, China has been promoting its EV industry for more than a decade with generous incentives to consumers and subsidies to automakers. Buyers have received discounts of as much as 60,000 yuan at one point for purchasing EVs. While new cars generally are subject to a 10% purchase levy, this has not applied to NEVs since 2014 and was recently extended through the end of 2023.

• China begins 6-month push to revive auto sales. According to various media reports, China has launched a six-month campaign to boost car purchases and drive electric vehicle adoption in rural areas as sales growth of EVs slow. The push, coordinated by the Ministry of Commerce, starts this month and will encourage financial institutions to provide credit support for car purchases and local governments and automakers to offer subsidies and discounts, especially on EVs. One key priority is to promote EV adoption in more than 11,000 counties and villages around China, with Beijing pledging to improve charging infrastructure in rural areas and nudge local authorities to launch support measures such as consumer subsidies. Earlier this month, the State Council said it would extend a tax break for new EV purchases, while in May, the country’s economic planning agency and the bureau of energy issued a call for the building of more charging infrastructure outside of big cities.
  
  Subsidies vary by region and it is not clear how much will be provided for purchases as many state governments are managing tight budgets and soaring debts. Nanjing said it will give out 35m yuan (USD5m) in car consumption vouchers from 6 June, providing up to 5,000 yuan for each qualifying car purchase. Shenzhen, a technology and manufacturing hub, has given out about 82m yuan (USD11.7m) to consumers, who bought EVs this year. Some auto manufacturers are also heeding the call to promote EVs in rural areas.
   
• China’s vehicle consumption is slowly recovering. According to China Passenger Car Association, passenger vehicle sales continued gaining momentum in May with YTD sales rising 2% to 7.29m units. Retail sales of NEVs surged 82% YoY to 483,000 units in May, bringing the YTD sales to 2.33m units, up 43% YoY. The association attributed the strong growth mainly due to sales promotions during the holiday in May and consumption subsidy policies introduced by the central and local governments. The accelerated car sales growth will help ease the spare part supplies situation in the coming months.
   
• Bullish on smart RGB LED sales growth. After 2 years of commercial production, smart LED sales volumes are finally seeing explosive growth with a projection of 50m units this year before hitting more than 140% growth in 2024, mainly driven by stronger demand from a German automaker. Management believes that it can contribute at least 12% to the group sales in 2024. It is accelerating progress in its own IC chip development, which should help diversify the risk of relying a single source of supply.

• Floor plans for Plant 2. The 2-1/2 storey building, which is slated for commercial operation by 4QFY23, is currently undergoing production line qualifications and pending various approval processes from its automotive customers. Under the plan, the top floor or ½ storey is catered for Dominant Electronics or the module business, the 1st floor is for the smart RGB LED production while the ground floor is vacant for now. Based on its customer forecast, management now expects Plant 2 to be fully utilized by end-2026.

• Update on smart projection LED. The prototype for smart projection LED, which covers exterior applications, is expected to be ready by end- 2023 before it enters the mass production phase for one of the German car models in 2024. The potential market volume is still relatively small with about 10m pieces per annum.

Source: PublicInvest Research - 12 Jun 2023