D&O Green Technologies - Upbeat On 2H Outlook

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Despite the slowdown in global car sales, management remains upbeat on the 2H outlook on the back of i) increasing capacity expansion, ii) higher adoption of LED usage as infotainment features have been gaining popularity in new car models, and iii) rising market shares. Backed by healthy design-in trends and greater efficiencies as a result of improved headcount, expanded floor space and new machineries, we expect to see margin improvements coupled with a strong pick-up in sales momentum towards 4Q 2022. Reiterate Outperform call with an unchanged TP of RM5.16 based on 35x FY23 EPS.

  • Healthy design-in trend. After seeing a spike in April, the company’s progress in design-in (initial success where customers consider design-in of Dominant products) remains steady, led by active enquiries from China, the EU (European Union) and US (United States) markets. We believe there could be more potential enquiries going forward as we gather that one of the global leading automotive LED makers has been scaling down its operations, potentially diverting its market share to the other automotive LED players. The Group’s order backlog currently stands at 1.5 months for some niche products, with order visibility remaining strong until year-end. As more new capacity is added in the 2H, we expect gross margin to normalize to 31%-32% as compared to the 1HFY22’s 28%. For 2022, we expect to see automotive LED capacity production growth of 30%.
  • Robust infotainment outlook. Driven by the increased demand for in vehicle entertainment such as on-demand music, live audio streaming, internet connectivity coupled with technological advancements in features such as graphic user interfaces, speech recognition and intuitive touchscreens, automakers are increasingly aware that these technology features could potentially influence a customer’s buying interest. Further, the ability to access cloud infrastructure and enable secure storage, direct access via Bluetooth or wireless internet, also helps fuel the interest for in vehicle infotainment. According to the Polaris Market Research, the global in-vehicle infotainment market size is expected to double from 2021’s USD20.5bn to USD48.62bn by 2030 with an expected CAGR of 10.9%. Management thinks that the forecast is conservative given the increasing application of automotive LED lightings and more innovations of LED usage in the pipeline.
  • Moving into large display panels. The automotive displays today are getting bigger and delivering higher resolutions. The instrument cluster, which houses several gauges like speedometer, odometer, tachometer, oil pressure gauge and fuel gauge, has seen an increasing demand for 7” and 12” displays. Meanwhile, center stack display, which contains a wide range of interactive content like navigation, cabin temperature controls and entertainment information, has seen rapid growth for sizes above 10”. Providing such display performance requires a great number of high brightness LEDs for backlighting, as well as LED drivers featuring multi channel operations and advanced dimming features.
    The automotive displays, which are generally based on thin-film transistors (LCD), will gradually see a technological shift from Edge-Lit display to Direct-Lit displays going forward as the traditional Edge-Lit technology is no longer applicable in big screens. LED consumption per car is projected to grow by 4-5x under the local-dimming backlight technology for Direct-Lit, where the LEDs are directly behind the LCD panels. Each LED can be dimmed individually to illuminate only those pixels of the display needed by dynamically adapting to the image content on the display. 
    The Direct-Lit display panel not only achieves greater contrast ratios (on par with OLED performance) and maintains high peak illumination, it is also more cost effective and requires less power consumption as the LEDs are not lit unless needed. Management shared that they have already secured some orders for Direct-Lit display panel and the prototype is expected to be ready by year-end with mass production taking place next year.
  • Cautious on Plant 2 capacity expansion. Due to inflated renovation costs in the 1H, management has decided to relocate the engineering office at Plant 1 to Plant 2, which will help to free up space for capacity expansion plans. Meanwhile, the Group has managed to save about RM2m-3m after shifting its renovation period from 2Q to 3Q. The renovation for clean room is almost complete, with commercial production expected to kick-off next month. Management remains confident that Plant 2 is on track to achieve full capacity utilization by end-2025.
  • Chip design development progressing well. The Group has been granted approval from the US for its first-of-its kind chip design, which consists of all three features, namely, analog, digital and memory. It can also help to cut down the number of components by connecting the LEDs without having another separate IC to do the transmission for another series of connector. It will submit a prototype sample to one of the leading automakers and is expected to take 2 years for the qualification process.
  • Smart LED production ramping up. Production of Smart LED has been ramped up at Plant 1 since 2Q 2022, and which will be relocated to Plant 2 when it is ready. Albeit contributing only 2%-3% revenue to the Group, the average selling price (ASP) is significantly higher. Meanwhile, projection lighting is expected to be released next year on a small-scale basis. The infra-red sensor product, which is a security feature for monitoring system, has completed all the reliability tests and is scheduled to be launched this year with design-in to follow shortly after.
  • Minimising unrealized foreign exchange (FX) fluctuations. To mitigate future FX fluctuations in the quarterly profit and loss statement, management has made some financial changes by i) reducing the USD borrowing (RM243.1m) from 88% to 50% by switching to MYR and RMB borrowings and ii) increasing the USD cash holding level to 50%. Nearly 50% of Group sales are denominated in USD while 50% of its cost of goods is denominated in USD, putting the company in a natural hedge position.
  • Eyeing another double-digit growth for 2023. The Group sees double digit growth continuing in 2023, driven by increasing infotainment application and ii) car body lighting. We gather that its clients in the European Union are pushing for early release for the car body lighting as it requires various reliability tests. The car body lighting is touted to be the new feature for upcoming electric vehicle (EV) car models. Management is confident that the new product can lead to strong design-ins for the company next year.

Source: PublicInvest Research - 26 Sept 2022

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