D&O remains optimistic about its outlook, driven by increasing demand for its SpicePlus, NagaJo, and smart LED modules which are benefiting from the rising global sales of electric vehicles (EVs). The company is streamlining its production processes to enhance efficiency and improve utilisation rates. Additionally, the recent strengthening of the Malaysian Ringgit (MYR) against the US Dollar (USD) is anticipated to result in some net foreign exchange gains in the upcoming quarter, assuming other currencies remain stable. We are maintaining our earnings forecasts for FY24 and FY25, with an unchanged TP of RM2.64. Maintain OUTPERFORM rating.

We recently met with D&O's management and remain optimistic about its promising outlook. The key takeaways from the meeting are as follows:

Optimistic about the prospects of its SpicePlus 2520 LED and NagaJo 1519 modules. The SpicePlus 2520 (refer to Exhibit 1-2) features a unique single footprint design across various power levels and colors, making D&O the first LED manufacturer to offer such versatility. This design simplifies circuit and lamp configurations, enhances heat dissipation through low thermal resistance, and reduces power consumption, while also facilitating easier replication and reuse, resulting in significant cost savings for automotive manufacturers. The company expects production to grow by 75% YoY, from 575m pieces in FY24 to 1b pieces in FY25.

The NagaJo 1519 (refer to Exhibit 3) product is tailored for front lamp applications, addressing market demands for improved performance and cost-effectiveness. Its compact and robust design enhances efficiency and contributes to weight reduction, making it suitable for modern vehicles. The small package outline improves durability and overall light performance. Released in 2022, the NagaJo 1519 module shipped 15m pieces in FY23, with plans to double shipments to 30m pieces in FY24 and again in FY25. We understand that D&O's Dominant is currently serving over 100 Tier-1 interior and exterior application customers.

Streamlining production methodology for higher efficiency with improved utilisation rates. The company has recently upgraded several machines, including those used for flip chip bonding and compression moulding, by integrating advanced technologies that have increased production efficiency by 2-3 times (refer to Exhibit 5-8). In 2QFY24, the group achieved a plant utilisation rate of approximately 70%, accompanied by a gross profit (GP) margin of 20%. Looking ahead, D&O expects utilisation rates to rise to 80% in 3QFY24 and 85% in 4QFY24, driven by broader LED applications and increased demand for its SmartLED (accounted for 10% group's turnover); company aims to deliver 86m pieces (+72% YoY) in FY24 and 147m pieces in FY25), SpicePlus 2520, and NagaJo 1519 modules. This growth is anticipated to elevate the GP margin into the mid-20s, reflecting enhanced operational efficiency.

Forex impact. The group is exposed to various foreign currency risks as its financial performance is influenced by multiple currencies due to its operations. Overall, D&O anticipates some net forex gains in the upcoming quarter, although the exact amount is still to be determined. Illustrated in exhibit 4, gains typically arise when USD costs exceed USD revenues, assuming other currencies remain constant. Additionally, if costs are incurred in USD while sales are made in Chinese Yuan (CNY) or Euros (EUR), this can also yield gains. However, these positive effects may be offset by losses if CNY sales exceed CNY costs and when considering MYR costs, such as labor and depreciation. According to its latest FY23 annual report, a 5% strengthening of the MYR against the USD-assuming other currencies remain constant-would have improved its FY23 PAT by about RM3.7m (or 8.4%).

Forecasts. Unchanged. We have maintained our utilization assumptions at 80% for FY24 and 81% for FY25, respectively.

Valuations. We maintain our TP at RM2.64, based on an unchanged targeted FY25F PER of 27x, in line with its peers' (i.e. Vitrox and Penta) forward average. The group's share price has pulled back by around 46% from its mid-June peak of RM3.94, which we believe is largely due to its weak 2Q24 results. This was driven by lower revenue and margins, primarily stemming from low utilization rates. Additionally, the strength of the MYR against the USD has put further pressure on tech players. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 6).

Investment case. 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. Maintain OUTPERFORM.

Risks to our call include: (i) a sharp decline in automotive demand, particularly for electric vehicles (EVs), (ii) an unexpected slowdown in the growth of the smart LED segment, and (iii) a general slowdown in the global economy.

World automotive LED lights landscape. The worldwide automotive LED lights sales are projected to expand at 8.1% CAGR from USD9.0b in 2024 to USD14.3b in 2030, mainly driven by the growth in electric vehicles (EVs), autonomous vehicles, government rulings and incentives (i.e. emission regulations and subsidies for hybrid and electric vehicles) and the need for safe driving, according to Mordor Intelligence. In terms of market breakdown, headlights accounted for most of the market share (51.8%) in 2022 followed by others (miniature LED lights, LED license plate lights, fog lights and interior LED lights), directional signal lights (DSLs), day time running lights and stop lights segments (refer to Exhibit 9).

The headlights segment is expected to continue gaining higher market share due to rising number of accidents. EVs are one the primary drivers for the surging demand for automotive LEDs globally. China led the EV market, accounting for 60% of global electric car sales in 2022, followed by Europe and the United States, which saw strong sales growth of 15% and 55%, respectively. The ambitious policy programs in major economies, such as the Fit for 55 package in the European Union and the Inflation Reduction Act in the Unites States, are expected to boost the market share of EVs.

Note that, the fit for 55 package in EU is a plan that aims to cut greenhouse gas emissions significantly. It includes rules that promote the use of electric cars, such as stricter limits on pollution from vehicles and financial incentives for buying EVs. Inflation Reduction Act from the US, meanwhile, is a law to provide tax breaks and incentives for people who buy electric vehicles. It also supports American companies that make EVs and their parts, making EVs more affordable and accessible.

EVs sales landscape. New EV sales reached nearly 14m (+35% YoY) in 2023, bringing the total number on the roads to 40m, boosting the EV market share from 4% in 2020 to 18% in 2023. Looking ahead, the research outfit is expecting the global electric car sales to reach 17m (+21% YoY) in 2024 and accounting more than 20% of the total global car sales.

Nearly 60% of new electric car registrations occurred in China in 2023, followed by just under 25% in Europe and 10% in the United States, collectively accounting for almost 95% of global EV sales. In these regions, EV cars constitute a significant portion of new car registrations, with over one in three new cars in China being electric, more than one in five in Europe, and one in ten in the United States. However, EV sales remain limited in other developed markets, such as Japan and India. This concentration of sales has also led to a growing concentration of the global electric car stock. Nevertheless, China, Europe, and the United States together account for approximately two-thirds of total car sales and stocks - highlighting the significant impact of the EV transition in these markets on global trends.

D&O's Dominant has over 100 Tier-1 interior and exterior application customers. It has risen from 6th position in global automotive LED supplier ranking in 2018 to 4th position in 2022 with 7% market share, after OSRAM (35%), Nichia (25%) and Lumileds (9%).

The rising adoption of EVs is driving demand for automotive semiconductor chips, as they require more processors than traditional vehicles. This surge in semiconductor demand is projected to positively impact the LED lighting market in the automotive sector, as advanced lighting systems become more prevalent.

Source: Kenanga Research - 16 Oct 2024