We reiterate our OUTPERFORM recommendation on D&O Green Technologies (D&O) with an adjusted TP of RM0.83 (previously RM0.91) after tweaking our FY20-21E earnings by –9% each to account for the slowdown during the MCO period. Our valuation is based on an unchanged FY20E PER of 22.6x, in line with its 3-year mean.

Solid 2H recovery. From our recent conference call with the management, we learnt that the outlook for the company remains positive, albeit temporarily disrupted by the Covid-19 outbreak. While there are some order deferment due to limited workforce (50%) during the movement control order (MCO) period, all orders are still intact. This could translate into a solid rebound in 2HFY20, driven by the recovery in China’s economy coupled with the easing of lockdown restrictions in the European region.

Gaining market share. The lockdown on a global scale has reemphasised the importance of dual sourcing and the automotive LED industry is taking appropriate measures to reduce the risk of supply chain disruption. This will in turn benefit D&O who has relatively smaller market share compared to peers but is ranked among tier-1 global players in terms of technology advancement and quality assurance. This is evident by its impressive reliability measure as it has a very low failure rate of 0.02 parts per million (PPM). Already having a strong grasp of the interior market, D&O is furthering its reach into the exterior market and is gaining momentum with products like the rear combination lamps (RCL).

Loosening car quotas. China has flattened the curve of Covid-19 cases and has restarted its economy. According to a recent poll conducted by the China Association of Automobile Manufacturers (CAAM), 90% of the car factories in China had resumed operations with approximately 66% of production capacity back online. Furthermore, the Chinese government is mulling loosening car quotas (notably electric vehicles) in tier-1 cities to boost sales for car manufacturers. Such action is in tandem with China’s aims to have electric vehicle (EV) at one fifth of total car sales (vs. 4.7% in 2019).

Tax break to further the cause. Over in Europe, a new car tax system has taken effect in April 2020. The new tax incorporates the Worldwide Light Vehicles Test Procedure (WLTP) standards that will increase car tax for all CO2 emitting cars but slashes tax on EVs from 16% to 0%. In addition, the increased penalty to €95 per g/km of CO2 exceedance (from €5 per g/km in 2019) will further emphasise the need for car manufacturers to pursue EV to average down their emission figures. More importantly, D&O’s growth does not solely depend on the growth of car unit sales, but the LED content per vehicle which will continue to increase as vehicles manufacturers move towards EV and autonomous vehicles.

Tweaked FY20-21E core PATAMI by -9% each to RM41-48m to account for the slowdown during the MCO period

Reiterate OUTPERFORM with an adjusted Target Price of RM0.83 (previously RM0.91) based on an unchanged FY20E PER of 22.6x, in line with 3-year mean. Being one of the few in the world to supply full range automotive LED, D&O is a prime proxy for the potential recovery in the automotive market, amplified by rising LED content in passenger vehicles and its augmenting market share.

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

Source: Kenanga Research - 22 Apr 2020