D&O posted a cumulative 1HFY23 core net profit of RM4.4m, down 93% YoY as automotive LED sales were badly hit by the slow car sales momentum in China, and higher cost pressures. The weak results made up only 6% and 4% of our and consensus full-year expectations, respectively. Despite the setback, we keep our earnings forecasts as we expect to see an exceptionally strong catch-up in the second half following replenishment of orders from China’s customers and also pick-ups in smart LED sales. We understand that the plant 1 is currently running at full capacity. Maintain Outperform with an unchanged TP of RM4.37 based on 35X FY24 EPS. No dividend was declared for the quarter.

• Mainly hit by weaker sales in China. 2QFY23 Group sales contracted 9.1% YoY to RM219.9m, hit by the slow car sales in China due to intensifying price competition and uncertainty over tax incentives. More cautious spending by Chinese consumers was also part of the key factors. The Asian market, which accounted for 64.4% of group sales, dropped 17.4% YoY to RM141.6m. The European market, its 2nd largest sales contributor, rose 10.4% YoY to RM56.3m meanwhile. Sales from the US market advanced 30.1% YoY to RM18.6m.

• 2QFY23 core profit tumbled to only RM2.6m. The Group saw its core profit shrink from RM35.1m to a paltry of RM2.6m, attributed to weaker automotive LED sales and higher operating costs. Meanwhile, 2QFY23 gross margin dipped from 27.9% to 16.2%, dragged by i) lower capacity utilization rate, ii) higher labour cost, iii) electricity tariff hike (additional of RM300k-400k/mth or +30% YoY), iv) higher borrowing cost (YoY: +310%) and v) depreciation cost (YoY: +25.3%).

• Stocking up inventories ahead of robust sales. We notice that the Group’s inventory has increased to an all-time high of RM499.8m, translating into a 6-month inventory level. We understand that the extremely high inventory level is to prepare for the robust sales growth in the second half of this year.

• Expecting higher capacity utilization in 2H. During the quarter, we estimate that plant 1 capacity utilization was slightly higher at around 65%. Following the recent meeting with its regional teams, management has gathered optimistic feedback and expects automotive LED sales volume to be fully booked until next month. We expect capacity utilization to hit above 80% in subsequent months. On the module (Printed Circuit Board Assembly (PCBA)) business, it has successfully secured a few projects from Hirain Beijing and is currently in talks with a few new customers. It is confident that it can breakeven by mid-2024. Overall, management maintains its overall target of single-digit sales growth for FY23.

Source: PublicInvest Research - 24 Aug 2023