D&O’s 1HFY23 results disappointed due to sluggish new orders and elevated overheads from an expanded capacity. Its prospects will remain subdued with weak consumer spending on large-ticket items such as vehicles. We cut our FY23F and FY24F earnings by 33% and 14%, respectively, lower our TP by 14% to RM2.30 (from RM2.68) and maintain our UNDERPERFORM call.

Below expectations. D&O’s 1HFY23 net profit of RM1.6m (-97.4% YoY) disappointed, as its 2QFY23 dipped to a new quarterly low in the last eight years, accounting for 1.6% of our full-year forecast and 1.3% consensus estimate. The variance against our forecast came largely from disappointing order restocking, leading to an underutilisation of production floor space and elevated overhead costs.

Results’ highlights. YoY, D&O's 1HFY23 revenue declined by 10%, primarily due to sluggish demand amid an inventory glut. Customers have become more hesitant to aggressively replenish orders as was the case in the past, aligning with the trend among tech players shifting from a just-in-case to just-in-time inventory system. Despite some QoQ improvement where revenue inched upwards 2.4%, it failed to offset the quicker rise in operating cost which resulted from its capacity expansion and higher utility cost. As such, gross profit margin remained subdued at 16.0% (vs. 27.9% in 1HFY23), which led to an overall 97.4%% decline in net profit for 1HFY23.

Challenges persist. With growing uncertainty surrounding the global economy coupled with underwhelming recovery from China’s reopening, consumers are likely to think twice before splurging on big ticket items. This has led to the group facing order commitments well below the initial rosy projections conveyed by customers. While the group anticipates some improvements in 2HFY24, we believe the rate of recovery will likely be unexciting.

Forecasts. We cut our FY23F and FY24F net profit forecasts by 33% and 14%, respectively.

Consequently, we reduce our TP by 14% to RM2.30 (from RM2.68) 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 resulting 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 - 24 Aug 2023