D&O’s 1QFY23 results disappointed as its top line slumped while overheads rose catering to its capacity expansion, leading to severe margin compression. With no strong order recovery in sight, it will rationalise its operations and headcount in accordance with the weaker order visibility. We cut our FY23-24F earnings forecasts by 25% and 24%, respectively, lower our TP by 24% to RM2.68 (from RM3.51) and maintain our UNDERPERFORM call.

Below expectations. 1QFY23 net profit of RM0.9m (-97.2% YoY) disappointed, slumping to the lowest quarterly earnings ever for the last eight years, accounting for only 1% each of both our full-year forecast and the full-year consensus estimate. The variance against our forecast came largely from poor order replenishments, resulting in underutilisation of its production floor space while overhead cost increased.

Results’ highlights. YoY, 1QFY23 revenue dipped 11% primarily due to its seasonally slower period coupled with a significant decline in automotive LEDs demand amidst the uneventful reopening of China’s economy during the reported quarter. Not helping either, the group’s fixed cost has increased following its capacity expansion and higher utility cost with new tariffs taking effect earlier this year. As a result, the group only registered a gross profit margin of 15.8% (vs. 27.9% in 1QFY23). Consequently, net profit plunged 97.2%.

Uphill battle. In the absence of a strong China reopening boost, manufacturers generally have received order commitments that are far lower than the initial optimistic forecasts as earlier communicated by customers. That said, the group will continue to take proactive measures to streamline its production processes and optimise its headcount based on a more realistic order visibility.

Forecasts. We cut our FY23-24F net profit forecasts by 25% and 24%, respectively.

Consequently, we cut our TP by 24% to RM2.68 (from 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 are cautious on D&O over the immediate term owing to the on-going inventory adjustments that may be prolonged and result in significant earnings erosion. Having said that, we acknowledge: (i) D&O’s presence in the high-growth automotive LED space, (ii) its penetration into the electric vehicle market, and (iii) its ventures into next-generation smart LEDs that fetch high margins. Maintain UNDERPERFORM.

Risks to our call include: (i) a strong-than-expected recovery in the global economy, especially in China; (ii) the inventory adjustment cycle ending sooner than expected; and (iii) contributions from its smart LEDs coming in sooner and stronger than expected.

Source: Kenanga Research - 30 May 2023