Stripping out exceptional items, D&O posted core net profit of RM117.3m, down 5.8% YoY. The results were below our and consensus expectations, making up only 81% and 89% of full-year forecasts, respectively. The disappointing numbers were a result of margin compressions arising from lower plant utilization due to softer sales in China, and the impact of higher labour cost. To minimize the impact of minimum wage increase, management has reduced its headcount by 240 through automating and streamlining the production process. Management sees a gradual recovery from 2Q 2023 as it plans to progressively increase its production in anticipation of pick up in China’s car sales following the reopening of its economy. We trim FY23-25F earnings forecast by 7-14% however, to reflect higher operating costs. Despite this temporary setback, we continue to like D&O’s growth prospects, and affirm our Outperform call with an unchanged RM5.16 target price.

• Dragged by weaker sales in China. During the quarter, group sales slipped 4% YoY to RM247m, as the group rationalized its inventory holding in view of softer demand from China’s automotive industry. All key regions except Europe contributed to the weaker automotive LED sales. The Asian market, which accounted for 73% of group sales, fell 3% YoY to RM181m. The European market, its 2nd largest sales contributor, rose 14% YoY to RM50m. Sales from the US tumbled 41% YoY to RM13m.

• 4QFY22 core profit tumbled 61% YoY. Stripping out the unrealized translation loss of RM3m, the Group posted core earnings of RM16m, down 61% YoY. Meanwhile, 4QFY22 gross margin contracted from 29.6% to 22.9%, dragged by lower capacity utilization. We estimate that capacity utilization was relatively lower at 50%-60% during the quarter compared to 75% in the 3QFY22. A massive capex of RM198m was spent in FY22 for new production lines, plant automation and quality improvements.

• Soft momentum persists in the first quarter. Passenger car sales in China slumped 38% YoY and 40% MoM in January to 1.29m as demand weakened during the Lunar New Year holiday, as others also placed orders before the electric vehicle subsidies was scrapped at the end of 2022. A total of 332,000 new energy vehicles were sold last month, down 6.3% YoY and 48.3% MoM. Production lines were halted for longer than usual and only a few dealerships remained open during the long Lunar New Year holiday in China. This was the first time since 2020 people were able to travel without being subject to Covid-related measures.

• Targeting another double-digit growth. Based on China’s car sales forecast of 4% growth coupled with the steady EV sales momentum, management is eyeing another steady growth this year. The renovation for the Plant 2 clean room is almost complete and one production platform will shift in from Plant 1. Management expects to see a jump in smart LED sales this year, which could potentially contribute 10% to the group sales. In-short, we expect to see a strong sales recovery in 2H compared to 1H. Key re-rating catalysts include the new contributions from module making business and Backlight Unit (BLU) LEDs for the display panel.

Source: PublicInvest Research - 23 Feb 2023