1H18 CNP is in line, so was the absence of DPS. FY18/FY19 prospects are bright, underpinned by: (i) better products portfolio, (ii) production capacity expansion, and (iii) higher stake in Dominant. Post results, slight earnings tweaks (+2% for FY18E/FY19E CNP) were made to account for stronger USD/MYR assumption. Maintain OP with a higher TP of RM0.830 (24.0x FY18E PER).

Within expectations. A strong 2Q18 CNP of RM7.8m (+21% QoQ; +69% YoY) was reported, bringing 1H CNP to RM14.5m (+24%) which made up 37%/36% of our/consensus full-year estimates. The core NP has been adjusted mainly for inventories and PPE write-down (RM4.47m), net gain on litigation settlement (RM3.15m), and other immaterial items, after deducting the portion of minority interest. We deemed the results to be within as financial 2H will see much better earnings on higher seasonal ramp-up alongside contributions of new products starting from 3Q18. Note that 1HFY CNP over the past two years made up 32-53% of the full-year numbers. Meanwhile, absence of dividend was as expected.

YoY, 1H18 revenue increased by 3% on adverse forex translations; as USD and CNY weakened by 10% and 3%, respectively, against MYR. Ex-currency effects, revenue would have increased by 10% YoY, underpinned by resilient automotive sales. Segmental-wise, automotive contributed 94% of the total revenue, which is in line with the group’s strategy to exit the highly competitive and less profitable LED market (general lighting and LED TV) to focus on higher-margin Automotive segment. While better GP margin was observed (+2.8ppt to 27.4%) which boosted GP by 14% YoY on better product mix from new sales of higher margin Automotive products, core NP indeed jumped by 24% on higher PATAMI contribution from the consolidation of Dominant. A fairer comparison at the core PBT level suggested an improvement of 13%, which is in-line with the GP level. QoQ, revenue was flat at RM113.3m on softer seasonality after the festival seasons in 1Q18. While this trickled down to flat GP (+1% on an unchanged GP margin of 27.5%), core NP, in fact, jumped by 21% on higher consolidation from Dominant (full effect from 61.84% to 89.8% stake).

Boiling point of expansion. D&O’s 5-year expansion plan with its new 2.41 hectare land-cum-factory building (additional 2x land area, which could house 3x additional capacity), is intact. Construction will be completed in 1H19. We only conservatively expect an additional 25-30% capacity from existing capacity until FY19, with sales assumption underpinned by Automotive products. In terms of product mix, high-margin (by certain ppt) exterior lightings contributed only 30% of total Automotive revenue in FY17. We expect a jump to c.45% share in FY19 to be anchored by new supply wins from Tier 1 Automotive LED customers stemming from new headlamps, alongside existing orders of Day Running Lights, Side signals, Position Lamps, Rear Combination Lamps, which are still seeing wide adoption in new vehicles. Meanwhile on its 70% sales denominated interior lightings, we gather that the group is already working on its smart RGB products (interior lighting) which would see commercialisation by 2020. Note that this single product could see ASP of at least 3x-4x higher than existing interior LED lightings. All in, we expect GP margin to hover at 26-27% (vs. 23-25% over the past two years) which anchor our 2-year CNP CAGR of 62%.

Maintain OP with a higher TP of RM0.830 (from RM0.810). While we made no changes to our earnings drivers, we tweaked our USD/MYR assumption from RM3.90/USD to RM4.05/USD. All in, our FY18E/FY19E earnings were increased by 2% each, which led to a higher TP of RM0.830 (still based on 24.0x FY19E PER, being its 3-year mean forward PER, which is also in line with the valuation of its closest global peer- OSRAM (Germany)).

Source: Kenanga Research - 23 Aug 2018