1Q19 core PATAMI came in below expectations at RM6.1m (- 5% YoY; -57% QoQ), accounting for only 15% of consensus full-year estimate and 13% of ours. The earnings disappointment likely stemmed from the Chinese imposition of tariffs on US vehicles and the introduction of WLTP. An interim dividend of 0.5 sen was proposed, as expected. Trim FY19-20E core PATAMIs to RM45.2-56.9m. Maintain MP with lower TP of RM0.650.

Below expectations. 1Q19 core PATAMI came in below expectations at RM6.1m (-5% YoY; -57% QoQ), accounting for only 15% of consensus full-year estimate and 13% of ours. The earnings disappointment likely stemmed from the Chinese imposition of tariffs on US vehicles and the introduction of the Worldwide Harmonised Light Vehicle Test Procedure (WLTP) emission regulation, both of which have impacted car sales in the group’s major markets. An interim dividend of 0.5 sen was proposed, as expected.

YoY, despite a 2% appreciation in the USD/MYR, 1Q19 revenue was flat, mainly due to sustained weakness in vehicle sales in the group’s major markets. Notably, light and passenger car sales fell 13% in China, 3% in the EU and 2% in the US, resulting in uninspiring automotive LED sales. Meanwhile, core PATAMI dropped 5% due to higher R&D and other administrative expenses, though partially offset by a lower effective tax rate of 18% (vs. 22% in 1Q18).

QoQ, 1Q19 revenue declined 20% mainly on seasonality – lower car sales at the beginning of the year. Traditionally, 4Q is the strongest quarter as D&O’s customers ramp up orders to prepare for stronger festive and year-end promotional period demands. Meanwhile, core PATAMI plunged by a larger quantum (-57%) primarily due to a 3-ppt contraction in GP margin on lower capacity utilisation.

Expansionary plan is intact. 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 still ongoing. Currently, we are conservatively assuming an additional 25-30% capacity through FY20, which supports our 26-27% earnings growth forecasts for the Automotive segment in FY19-20. In addition, the group is striving to progressively increase contribution from the higher-margin exterior lightings to 50% over 2-3 years (vs. 35% of total Automotive revenue in FY18). This is anchored by new supply wins from Tier 1 Automotive LED customers, especially in the headlamps space, alongside existing orders of Day Running Lights, Side signals, Position Lamps, and Rear Combination Lamps, which are still seeing rapid deployment in new vehicles. Meanwhile, on interior lightings, the group is currently working on its smart RGB products and targets commercialisation by 2020. We note that the smart RGB products could see an ASP that is at least 3-4x higher than existing interior LED lightings.

Trim FY19-20E core PATAMIs by 7% to RM45.2-56.9m as we tone down our revenue forecasts by 7% to account for cloudy global economic outlook amid heightened tension from the current trade war. We believe the trade war could affect consumer sentiment and spending on cars, at least in the short-to-medium term.

Maintain MARKET PERFORM with lower Target Price of RM0.650

based on FY19E PER of 18.0x, in line with the valuation of its German competitor – OSRAM. While D&O offers exciting long-term growth prospects, its near-term earnings visibility is clouded by the uncertain environment created by the trade war. Additionally, we believe valuation is stretched at current price levels.

Risks to our call include: (i) disruption of components supply, (ii) replacement/obsolescence of LED technology, (iii) sharp currency fluctuations, and (iv) adverse foreign labour policy.

Source: Kenanga Research - 24 May 2019