KEY INVESTMENT HIGHLIGHTS

• 3QFY20 normalised earnings of RM12.3m (+21.5%yoy), supported by new business wins and recovery in demand

• Cumulative 9MFY20 financial performance of RM19.9m (-7.7%yoy), came in better than our expectation

• The group’s current valuation of more than 30x appears stretch at this juncture

• Dividend outlook to remain tepid as bulk of the cash generated is expected to be reimburse for future expansion

• Downgrade to NEUTRAL with a revised TP of RM1.54

Delivered record quarterly revenue. D&O Green Technologies Bhd (D&O) 3QFY20 normalised earnings came in at RM12.3m, an improvement of +21.5%yoy. This was premised on higher revenue of RM158.9m (+26.2%yoy) which represent the group’s highest quarterly revenue. Demand from the automotive segment, especially from China has rebounded strongly while the Europe and US markets has also shown some recovery in sales. Moreover, the group had also secured new business wins which further boost the revenue.

Exceeded expectations. Despite the stellar 3QFY20 results, 9MFY20 normalised earnings still came in lower at RM19.9m, a decline of -7.7%yoy. Nonetheless, we view that the group’s 9MFY20 financial performance has exceeded ours and consensus expectations, although it only accounted for 62.7% and 61.9% of full year FY20 earnings estimates respectively. Based on historical trend, fourth quarter earnings would usually be the group’s best quarter performance for the year which is in-tandem with its customer demand. Premised on this, the group’s fourth quarter results would come in stronger as compared to the third quarter.

Capex. The company’s 9MFY20 capex came in at RM39.0m. This represents a decline of -33.6%yoy as compared to RM58.7m spent for 9MFY19. The lower capital spending premised on the disturbance created by the Covid19 pandemic. The capex was mainly spent on tools and equipment for new product lines, machinery upgrades, plant automation, QC improvements and construction of new factory.

Impact. We are increasing FY20-FY22 earnings higher to between RM34.7m to RM68.1m mainly to account for the new business wins and healthier profit margin.

Target price. We are rolling forward our valuation base year to FY22 and derive a new target price of RM1.54 (previously RM1.01). This is premised on pegging FY22 EPS of 5.3sen against forward PER of 29.0x.

Our target PER is two standard deviation above the two year historical average PER of 22.6x. Given the uncertainty due to Covid-19 pandemic, we view that D&O earnings visibility to sustain due to its strategic positioning within the automotive industry. In addition, we also favour the group’s continuous design win which would create a snowball effect on the group’s income generating ability.

Downgrade to NEUTRAL. In June 2020, there was a sharp reversal in production activities to pre-pandemic level which was mainly due to robust demand growth in China and gradual recovery of global automotive sales, especially in Europe and US. As the impact of the pandemic dissipates, we will continue to see strong earnings growth primarily from the China. This will be driven by higher adoption of LED, especially the smart RGB LED which is expected to contribute meaningfully to the company’s earnings from FY21 onwards. Note that China has extended subsidies and tax breaks for new-energy vehicle purchases by two years until the end of 2022 in the wake of the Covid19 pandemic. However, given the resurgence of Covid-19 cases in Europe and elevated Covid-19 cases in US, we expect the recovery in both markets to be slower than anticipated. On another note, we view that D&O’s current valuation of about 37x appears stretched at this juncture. This could limit potential upside in the near term. While earning is expected to continue to grow, we view that it would not translate into higher dividend payout as the group intends to reserve the cash to fund future expansion. As such, we expect dividend yield to hover around one percent. All factors considered, we are downgrading our recommendation for D&O to NEUTRAL from Buy previously

Source: MIDF Research - 25 Nov 2020