D&O posted core profit of RM0.9m, down 97% YoY as automotive LED sales were badly hit by a sharp decline in China car sales and higher cost pressures.  The unexpectedly weak results made up only 0.6% of our and consensus full-year expectations. Despite the setback, management aims to achieve revenue growth this year. China’s April passenger car sales surged 55% YoY coupled with the recent price hike by Tesla, indicating that the operating environment is finally becoming supplier-friendly and the cycle of declining earnings trend appears to be coming to an end. Nevertheless, we cut our FY23-25F earnings forecast by 21%-50% after lowering our margin assumption. Maintain  Outperform with a lower TP of RM4.37 based on 35X FY24 EPS.

• Mainly hit by weaker sales in China. 1QFY23 Group sales contracted  11% YoY to RM214.7m, hit by a sharp decline in car sales due to long  Lunar New Year holidays and an overhang of car inventory in China. The consecutive cuts in car prices also contributed to weaker sales as consumers adopted wait-and-see attitudes. All key regions except Europe contributed to the weaker automotive LED sales. The Asian market, which accounted for 64% of group sales, dropped 18% YoY to RM137m. The  European market, its 2nd largest sales contributor, rose 18% YoY to  RM59m meanwhile. Sales from the US retreated 22% YoY to RM14m.

• 1QFY23 core profit dived to only RM0.9m. The Group saw its core profit  shrink from RM31.6m to a paltry of RM0.9m, attributed to weaker automotive LED sales and higher operating costs. Meanwhile, 1QFY23 gross margin dipped from 27.9% to 15.8%, dragged by i) lower capacity utilization rate, ii) higher labour cost, iii) electricity tariff hike (additional of  RM300k-400k/mth or 30% YoY), iv) higher borrowing cost (YoY: +516%)  and v) depreciation cost (YoY: +32%).

• High expectation of smart LED sales. Smart RGB LED sales volume is  expected to rise from 40m to 50m pieces this year before hitting 240m  pieces in 2025 on the back of higher demand from its German client.  Despite seeing lower selling prices, sales contribution to the group is expected to increase from 3% to 10% this year. Meanwhile, the prototype  for its smart projection LED and infrared is expected to be ready by year-end before it enters commercial production phase next year.

• Capacity utilization. The group’s average utilization has been in the  range of 65% to 70%. Based on our rough calculation, we estimate that  plant 1 capacity utilization for 1QFY23 stood at 65%. Meanwhile,  renovation for Plant 2’s clean room has been completed and the construction of an extension building for the supporting areas is currently  underway. The production line qualifications and approval process from its  automotive clients will be carried out in 3QFY23 and is targeted to enter commercial operation in 4QFY23 with a target of full capacity utilisation by  2026. The construction of Plant 3, which costs about RM200m, is expected to take place in 1Q 2024. Lastly, management has budgeted capex of  RM100m-120m for FY23 with RM29.3m spent in 1Q to cater for new production lines, machinery upgrades and plant automation.

Source: PublicInvest Research - 30 May 2023