After attending D&O’s 4QFY22 briefing, we learnt that the group is bracing for a challenging operating environment in 1HFY23. Owing to slow activity in China despite the easing of Covid restrictions, 1QFY23 is expected to further soften QoQ. For now, customers are still in an inventory optimisation mode but there are signs for order recovery in the second half of the year. We maintain our forecasts, TP of RM3.51 and UNDERPERFORM call.
We attended D&O’s 4QFY22 results briefing with the following key takeaways:
1. D&O guided for a challenging operating environment in 1HFY23 with a soft first quarter owing to: (i) seasonal factor, (ii) Chinese New Year holidays, and (iii) high Covid cases. Unfortunately, the Shanghai office experienced a 100% infection rate during January. Not helping either was the increased electricity cost which came into effect Jan 2023. This will result in an additional 30%-38% power cost to RM1.7m-RM1.8m per month.
2. To improve operating cash flow and synchronise its production to customer's weak demand, the group has initiated an inventory rationalisation plan that encompasses: (i) decelerating its smart LED design-ins activity, (ii) reducing 10% of workforce, and (iii) incorporating additional automation processes.
3. The group is designing new products (such as infotainment display, intelligent signal display and car body lighting) which are expected to enter prototype stage in early FY24. D&O also recently made headway in its electronics segment by securing a new customer for electric vehicle control unit assembly which will commence production in 2QCY24.
Forecasts. D&O still expects double-digit sales growth in FY23 with smart LED making up 9-10% of the group revenue. This is premised on an aggressive ramp up in 2HFY23 in anticipation of a bumper 4Q. We maintain our forecast as we believe our numbers are reflective of the expected growth.
Investment thesis. We like D&O for: (i) its unique exposure in the automotive LED business, (ii) its penetration into the electric vehicle market, and (iii) venture into next-generation smart LEDs which yield higher margins. However, we remain cautious in the immediate term owing to the on-going inventory adjustment. Its valuation has become rich after the recent run-up in its share price.
Reiterate UNDERPERFORM and TP of RM3.51 based on 25x FY24F PER, in line with peers’ forward average. There is no adjustment to our TP based ESG given a 3-star rating as appraised by us (see Page 4).
Risks to our call include: (i) sharp increase in automotive demand, (ii) faster-than-expected ramp up in its smart LED segment, and (iii) quickerthan-expected recovery in the global economy.
Source: Kenanga Research - 24 Feb 2023