INVESTMENT HIGHLIGHTS

• Production capacity expansion on track
• Exterior LED and new products to drive future growth
• Acquisition of 27.95% of Dominant shares to be concluded by 1Q18
• Expansion initiatives to have earnings impact only from FY19F onwards
• Maintain NEUTRAL and TP of RM0.66

Production capacity expansion on track. We came away feeling reaffirmed of D&O’s long-term expansion plan after visiting its plant recently. The company is installing new generation production lines that require less floor area. The company plans to relocate the administrative office to the new property in 2H18. With the additional floor space and newer production lines, its production capacity can potentially double from the current level upon completion of the relocation and installation of new machines. Any positive earnings impact is only expected from FY19F onwards. Recall that D&O has purchased the adjacent factory for RM11m and will carry out the expansion in stages up till 2023. Ultimately, the total production capacity together with the new plant can be three to four times its current capacity as the new machines take up less floor area.

Exterior LED and new products to drive future growth. Currently, LED for exterior lighting makes up about 25% of its automotive lighting sales. The ratio is expected to increase gradually to 40% in five years’ time. On top of that, it is also targeting to roll out its smart red green blue (RGB) product, which commands close to 10 times the average selling prices of existing products, in FY19. With the shift to higher exterior LED lighting and smart RGB, we anticipate for profit margins to improve in the next two years. For FY18F, we had anticipated a 1.1ppt yoy improvement for its EBIT margin.

Acquisition of 27.95% of Dominant shares to be concluded by 1Q18. The EGM for the acquisition of the additional 28% stake in its main income contributor Dominant will be on 21 Feb. The exercise will see an issuance of 451.17 million irredeemable convertible preference shares (ICPS) in D&O, which is expected to be concluded by 1Q18. We have previously anticipated for earnings impact that’s limited to 1.4% from this exercise. We do not anticipate immediate conversion of the ICPS to the D&O shares as the company’s free float is hovering around 26%. Overall, the impact of this exercise is expected to be neutral.

Source: MIDF Research - 9 Feb 2018