Despite experiencing some hiccups last year, we affirm a few positive takeaways to reiterate our upbeat stance on D&O Green Technologies (D&O) following its 4QFY22 post-results briefing. China’s auto market has been boosted by the extension of exemptions on new energy vehicle (NEV) purchase tax announced a week ago. Smart RGB LED is set to be one of the key growth drivers this year given the estimated surge in sales contribution. We are also looking forward to the upcoming release of Direct-Lit display LED, which has huge market potential once it enters mass production phase. In-short, we expect to see a strong pick up of sales growth in 2H. Maintain Outperform with a higher TP of RM5.78 (RM5.16 previously) based on 35x to a rolled-over F24 EPS.

• 4QFY22 results round-up. Due to cost pressures coming from the minimum wage hike and softer-than-expected final quarter of the year (which is typically stronger, seasonally) due to de-stocking by customers, the company’s financial performance was negatively affected as utilization rate slipped from 75% to 55%. We believe D&O can ramp up its utilization level to at least 80% this year, as reflected in our earnings estimates.

• A new milestone for its first chip design. To mitigate the risk of high dependency on its chip supply for smart LEDs, the Group has embarked on its own chip design and plans to commercialize the product in 2024, which is ahead of its expected timeline. The first-of-its-kind physical chip, which has the functionality of analog, digital and memory, has received a patent for communication configuration from US in November 2022. The chip layout has been completed, with the package qualification in progress and targeted to be completed by 3Q 2023. Before mass production takes off, it has scheduled two rounds of “multi-project wafer programme” for prototyping purposes. According to Wikipedia, it is a process whereby different chip designs are aggregated on a wafer, with a different number of designs/projects per wafers. It enables effective support for different phases and needs of manufacturing volumes of different designs/projects. Selecting the right service platform at the prototyping phase ensures gradual scaling up production.

• High hopes on Direct-Lit display LED. We understand that the migration from Edge-Lit to Direct-Lit display could kick in as early as end-2023. Based on the market projections of 800-1,000 Back Light Unit (BLU) LEDs per panel for each car, coupled with an expected market share of 25% on high end car applications, the product could potentially see an encouraging annual volume of 6bn pieces. Using the conventional LED average selling price as the benchmark, potential sales contribution from the display panel BLU LEDs could be on par with the conventional LEDs. With this, D&O will solidify its leading position considering the wider range of display LED products.

• Venturing into module business. Under the subsidiary of Dominant Electronics, the Group has secured its first Printed Circuit Board Assembly (PCBA) job from a tier-1 automotive player based in China that supplies to the world’s 5th largest automaker. The first project, which is mainly involved in assembling electric vehicle control units, is slated for mass production in March 2024. Once the first project kicks off, it is believed that there will be another bigger module project in the pipeline. Together with Dominant Electronics, the Chinese customer, which will handle the back-end testing job, will occupy the 3rd level of Plant 2. Management expects this new segment could potentially contribute 10%-20% to Group sales in 2025/26.

• Rebound in China car sales. Despite seeing a slump in January car sales due to the long holiday break, China’s car sales are expected to see strong recoveries in subsequent months. On a positive note, China’s Deputy Minister for Finance, Xu Hongcai announced last Friday that the exemption on New Energy Vehicle (NEV) purchase tax, which equals to 10% of a car’s retail price, will remain intact this year. To further stimulate the recovery in demand, we think automakers may subsequently offer various measures including discounts, financing plans and subsidy for replacement vehicles. According to the China Passenger Car Association, retail sales of passenger vehicles in the country may have reached 1.35m units in February, up 7.2% YoY and 4.3% MoM. Our channel checks reveal that all Chinese NEV startups except Xpeng Motors reported higher deliveries last month. Notable player, BYD, saw its NEV sales jump by 119% YoY, placing it first for NEV sales in China for the 21st month in a row.

• Plant 2 commences operations. As Plant 1 is fully utilized, Plant 2, which is 56% larger than Plant 1, will start commencing production this month. The 269,000 sq ft-new manufacturing plant, which caters for the production of i) smart RGB LED, ii) BLU LED and iii) module making (PCBA), will ramp up its production capacity by about 10%-15% in the first year and is expected to be fully filled up by end-2025. One of the two production platforms, namely strip-to-strip, that is mainly catered for low production volume and high margin products, has shifted from Plant 1 in order to free up some spare capacity for the main production platform (reel-to-reel), which is catered for the high production volume products like DomiLED, Mini DomiLED and etc.

• Smart RGB LED demand surpassing previous target. Management has targeted smart RGB LED sales volume of 80m this year, which is significantly higher compared to the previous forecast of 34m. It is also a 2- fold jump compared to the 2022 sales volume. Based on our estimates, smart LED sales could potentially contribute at least 10% to Group sales this year. We also understand that D&O’s smart RGB LED products are currently in the leading position globally, based on the range of products it offers and its technological development.

• Outlook guidance. Management plans to be more stringent in capacity expansion this year as it has sufficient capacity until 3QFY23. It has allocated about 10% of annual revenue for capital expenditure this year, which will likely be in the third quarter. Given the current spare capacity, we think there is no issue to ramp up production, which takes about 3 months, in the event there is a surge in demand. In view of heightening cost pressures coming from i) sharp increase in electricity tariff ii) higher minimum wage rate and iii) lower number of weekly working hours, management has revamped its working shift and reduced its headcount by 240, with more automation in place. For FY23, management has set a mid teen sales growth target and expects to see margins normalize in the 2H.

Source: PublicInvest Research - 15 Mar 2023