1QFY19 core PATAMI came in below expectations at RM3.9m (-36% YoY; -72% QoQ), representing only 10% and 9% of our and consensus full year estimates. The variance to our numbers was largely attributable to the MCO which resulted in lower gross margin as the group’s capacity was underutilised. Looking beyond the widely anticipated soft 1H, we expect a U-shape recovery for the group going into 2H as their utilisation rate has recovered to pre-Covid 19 levels, supported by encouraging signs of recovery in China. We roll forward our valuation base to FY21E. Maintain OUTPERFORM with a higher TP of RM0.86.

Below expectations. 1QFY19 core PATAMI came in below expectations at RM3.9m (-36% YoY; -72% QoQ), representing 10% and 9% of our and consensus full year estimates. The variance to our numbers was largely attributable to the movement control order (MCO) which resulted in the group operating at a less than desirable level from mid-March till end May.

YoY, revenue for 1QFY20 inched up 4.5% to RM115.5m. Automotive revenue (which constitutes circa 97% of group revenue) rose 5.3%, owing to strong automotive demand which spilled over from end-2019. The group was able to meet demand with spare inventory. In turn, the production floor was underutilised which led to a decline in gross margin.

QoQ, PATAMI fell 72% on a 22% decline in revenue. While the decline is large, such comparison is less meaningful due to high base effect as automotive sales are seasonally higher during that period.

U-shape recovery for 2H. Looking beyond the widely anticipated soft 1H, which is understandable as only 20% of its workforce was operational during the MCO, we expect a U-shape recovery going into 2H as the group’s utilisation rate has recovered to pre-Covid 19 levels. The group also shared the same optimism for LED demand outlook for the later part of this year as China automotive market has shown some encouraging numbers. China passenger car sales climbed 14.5% YoY in May, an improvement from -43% YoY in March. Consumption-spurring policies such as the extension of subsidies and tax exceptions for EVs by another two years helped fuel the pent-up demand. As for the European market, gradual easing of restrictions will likely lead to improvement in car sales due to extra tax incentives.

As one of the pioneers of smart RGB, D&O is well positioned to reap the benefits as car makers adopt such technology. Smart RGB yield higher ASP and allows for local dimming which results in better contrast and lower power consumption. With battery as the main power source for EVs, even marginal power saving from LED makes a difference in terms of driving range. Such savings become even more pronounced with the increase in LEDs per vehicle, in tandem with market trend to improve both safety and aesthetics.

Cut FY20E and FY21E core PATAMIs by 27% and 10% to RM29.9m and RM42.9m, respectively, to reflect lower output level in the 1H due to lacklustre demand during the lockdown period.

Maintain OUTPERFORM with a higher Target Price of RM0.86 as we roll forward our valuation base to FY21E. Our valuation is based on an unchanged PER of 22.6x, representing +1SD above 2-year peers’ average. Being a renowned brand name in full range automotive LED, we believe D&O is a prime proxy for the potential recovery in the automotive market.

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 - 17 Jun 2020