D&O’s FY22 results disappointed as the expected bumper 4Q failed to materialise. Gross margin compressed to 26.5% from 29.8% owing to higher fixed cost from the underutilisation of its expanded production capacity. It expects orders to only pick up after 1QFY23, driven by China’s reopening. We moderate down our FY23F net profit by 8%. Current valuation is also stretched after the recent run-up in its share price. Thus, we downgrade our call to UNDERPERFORM from MARKET PERFORM with an unchanged TP of RM3.51.

Below expectations. FY22 core net profit of RM97.3m (-12% YoY) came in below expectations, missing our and consensus full-year forecast by 7% and 25%, respectively. The variance against our forecast was due to lower-than-expected orders from customers resulting in under-utilisation of its production floor space while overhead cost increased.

Results’ highlights. YoY, FY22 revenue climbed 16% higher on healthy demand for LEDs despite flattish global car sales growth in 2022. The commendable achievement was attributable to the group’s continuous effort in pursuing business-wins as well as organic increase in LED content per vehicle. However, gross profit margin trended lower to 26.5% (vs. 29.8%) as a result of higher fixed cost following new capacity expansion in Plant 2 and the increase in foreign labour wages. This was further exacerbated by workforce expansion as the group was anticipating a bumper 4QFY22 which failed to materialise due to the prolonged zero-Covid policy in China. Since then, the group has taken quick action to reduce its workforce by c.10% to 2,740 as a cost reduction measure and focuses on automating more processes.

Immediate challenges remain. In a seasonally weaker 1QFY23, the group anticipates orders to remain lacklustre given that activities in China was mostly at a standstill during January, owing to high Covid cases as well as the Chinese New Year holidays. This is evidenced by the large decline in January car sales (-35% QoQ; -32% YoY) as reported by the China Association of Automobile Manufacturers (CAAM). Meanwhile, the European Automobile Manufacturers' Association (ACEA) also saw sales falling 15% QoQ in the same month while rising 11% YoY due to an unusually low base effect in Jan 2022.

Forecasts. We moderate down our FY23F net profit by 8% and introduce FY24F earnings of RM173.5m. However, we keep our TP of RM3.51 based on an unchanged FY24F PER of 25x, in line with peer’s forward average. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment thesis. We like D&O for: (i) its unique exposure to the automotive LED business, (ii) its penetration into the electric vehicle market, and (iii) venture into next-generation smart LEDs which yield higher margins. However, we remain cautious in the immediate term owing to the on-going inventory adjustment. Its valuation has become rich after the recent run-up in share price. Therefore, we downgrade our call to UNDERPERFORM from MARKET PERFORM.

Risks to our call include: (i) sharp increase in automotive demand, (ii) faster-than-expected ramp up in its smart LED segment, and (iii) quickerthan-expected recovery in the global economy.

Source: Kenanga Research - 23 Feb 2023