We expect significant recovery in 2H owing to strong automotive demand in China coupled with improving market conditions in Europe. Further tax incentive from government will spur automotive buying, especially EVs. The group maintains a healthy pipeline with continuous innovation for new product applications. Maintain earnings estimates and reiterate our OUTPERFORM recommendation on D&O with an unchanged TP of RM0.86.

Robust 2H recovery as lock-down eases. We came away from a recent conference call with the management having an optimistic view for 2HFY20 as the lock-down restrictions have been lifted. The group has recovered to full workforce for the month of June to meet order backlogs. Our earnings forecast reflected a soft 1H as we expect the movement control order (MCO) to impact subsequent quarter negatively. Beyond that, we are seeing encouraging signs from external demand as China car sales have recorded growth of 4.4% YoY and 14.5% YoY in April and May, respectively. This is a significant improvement from the 43% YoY decline in March. Meanwhile, Europe car sales have shown early signs of bottoming out as the pace of decline has slowed, from - 78% YoY in April to -57% in May. As Covid-19 lockdown eased further, we expect car sales to pick up gradually with more promising momentum in 2H 2020.

Continuous innovation and improvement. The group indicates a healthy pipeline as it continues to work with customers on new innovation and applications to increase automobiles’ safety and aesthetics. This includes functions such as local dimming and multicolour LEDs while maintaining relatively low power consumption. Already having a good foothold in the interior LED market, the group is working to expand its presence further in the exterior LED market with products like the rear combination lamps (RCL).

Government incentives to spur car sales. The Chinese government has lifted 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). Authorities have also taken necessary action to encourage local banks to be more lenient on automotive loan. Over in Europe, local government are relaxing car tax and doubling down on incentive specifically for EVs. For illustration, the French government is giving out as much as 12,000 euros rebate on a new electric car. This means that a brand new Renault Zoe will only cost 20,000 euros instead of 32,000 euros, representing a sizable discount of 38%. In addition, the newly enforced Worldwide Light Vehicles Test Procedure (WLTP) standards 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.

Maintain FY20-21E earnings estimate and reiterate OUTPERFORM and Target Price of RM0.86 based on an unchanged FY21E 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 - 18 Jun 2020