D&O’s 9MFY23 results disappointed as customers restocking though picked up in 3QFY23 fell short of expectation. There are signs of recovery for its customers in China while the demand from Europe and the US is stable. Yet, we find it difficult to justify FY24F PER of >50x. We cut our FY23-24F earnings forecasts by 29% and 24%, respectively, but keep our TP of RM2.30 and UNDERPERFORM call.

Below expectations. D&O’s 9MFY23 net profit of RM19.8m (-76.3% YoY) disappointed, accounting for only 31% and 37% of our full-year forecast and the full-year consensus estimate, respectively. The variance against our forecast came largely from a slower–than-expected pick-up in restocking by its customers.

Results’ highlights. YoY, D&O's 9MFY23 revenue eased 4% due to inventory overhang in 1HFY23 resulting in slow orders as customers pared down their inventories. Its net profit fell by a steeper 76% attributable mainly to unabsorbed fixed costs incurred during capacity expansion amid declining orders, an increase in minimum wages for workers and higher electricity tariffs. Its net profit margin shrank to 2.8% (vs. 11.4% in 9MFY22).

QoQ, its 3QFY23 net profit surged to RM18.2m (from RM0.7m in 2QFY23) as orders from China surged in-line with a pick-up in China’s economy. However, the market had already priced in a much stronger recovery.

Forecasts. We cut our FY23-24F net profit forecasts by 29% and 24%, respectively.

However, we keep our TP of RM2.30 based on a rolled-forward FY25F (from FY24F) PER of 25x, in line with the forward average of its peers such as INARI, VITROX and PENTA. 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 believe its earnings have bottomed out driven by a gradual return of orders from China, and the stable demand from Europe and the US. Yet, we find it difficult to justify PER of 51x and 39x for FY24-25F, at a 79% and 54% premium respectively to its peer’s averages. 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 stronger-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 - 27 Nov 2023