• Shifting to a higher production gear

• Better margins with higher auto contribution

• However, much of the positives have been priced in

• Initiate with NEUTRAL and TP of RM0.66

Business Overview:

D&O Green Technologies Bhd (D&O) manufactures and markets light emitting diode (LED) products under the brand Dominant. Almost all its products are exported while D&O has six sales offices worldwide.

Investment Theses: 1. Shifting to a higher production gear. D&O’s current plant utilisation rate has increased to 70% to 80% from 60% to 70% in the previous quarter, indicating that the company is getting busier in fulfilling customers’ orders. It has also acquired a new plant earlier this year that will allow the company to double the current production capacity upon completion in 2023.

2. Margins should improve as automotive segment contributes more. In the past three years, the company decided to pare down its general lighting sales to focus more on automotive lighting. General lighting segment accounted for 50% of sales in 2014 and has since been reduced to less than 10% now. Inversely, automotive lighting is main income contributor. Since then, its gross profit margin has also improved from 15% in FY14 to 25% as at 1Q17.

3. 4-year profit CAGR of 40%. From FY15 to FY18F, D&O’s net profit CAGR is expected at 40%. We expect PAT to grow by 74% in FY17F and another 37% in FY18F as the company continues to fulfil orders from its customers. This is also helped by the higher margins from automotive LED lighting. Growth in demand will come from the wider application of LED and the overall growth in the automotive industry.

4. However, much of the near-term positives have been priced in. While we like D&O’s growth catalysts, we believe that its current valuation is considerably high as its share price has more than doubled year-to-date. We reckon that the company will only experience another high growth from FY19 onwards.

Initiate with NEUTRAL and TP of RM0.66. This is based on PER of 25x pegged on FY18F EPS of 2.6 sen. The 25x PER is a slight discount to the average PER of global lighting players such as Phillips and Osram, which stands at 27x.

VALUATION

Initiate with NEUTRAL and TP of RM0.66. This is based on PER of 25x pegged on FY18F EPS of 2.6 sen. The 25x PER is a slight discount to the average PER of global lighting players such as Phillips and Osram, which stands at 27x. Based on Bloomberg data, D&O’s semiconductor peers that include Globetronics and Unisem are trading at an average PER of 39x. Meanwhile, global lighting companies that include Osram and Phillips are trading as an average PER of 27x. Taking all these into consideration, we decide to use 25x PER due to D&O’s smaller size and niche position in the auto LED market. It is also the only listed company on Bursa with such a positioning as other semiconductor players listed on Bursa manufactures different products.

RISKS

Rapid shift in technology. The introduction of new lighting technology that is more cost effective than LED is likely to change the landscape that D&O operates in. The improvement in technology also generally leads to lower ASPs, price and margin erosion especially for the older range of products. The inability for the company to change with the new trends may result it in falling behind competition. That said, the company has an R&D team and looks into new machines and products while it allocates 3% to 4% of its sales for R&D purposes.

Huge swing in forex movement. As D&O derives most of its income from export sales, a stronger ringgit against some major currencies it trades in will impact its top and bottomline adversely. The company tries to mitigate its forex risks by being exposed to several major currencies namely USD, renminbi and euros. The company receives 60%, 25% and 15% of its income in these currencies respectively. We believe that this diversification reduces its risks from being too reliant on the movement of a single currency, hence cushioning it from a single currency risk.

Foreign labour issues. The company currently hires a few hundred foreign workers. Any unfavourable change in policies in regards to foreign labour will adversely impact its operational costs. A severe shortage in foreign labour supply can also reduce its productivity. The company aims to mitigate this risk through more automation and reduction in laborious headcount by using more advance machineries.

Source: MIDF Research - 21 Aug 2017