D&O Green Technologies Bhd
(Nov 29, 80.5 sen)
Downgrade to neutral with a lower target price (TP) of 86 sen: D&O Green Technologies Bhd’s (D&O) second quarter ended June 30, 2018 (2QFY18) normalised earnings came in at RM9.6 million, which represents an increase of +18.6% year-on-year (y-o-y).

 
The growth in earnings was mainly attributable to increase in automotive LED sales to RM117.5 million. This was further boosted by better cost management, and production efficiency improvements.

Nonetheless, the rise in earnings was partially offset by higher research and development expenses which were attributable to additional product test qualifications for new and existing products.

Driven by the growth in 3QFY18 normalised earnings, D&O’s cumulative nine months ended Sept 30, 2018 (9MFY18) normalised earnings came in at RM24.5 million (+40.0% y-o-y).

This is below ours and consensus expectations, accounting for 58.3% and 60.0% of full- year FY18 earnings estimates respectively.

Nonetheless, we are expecting 4QFY18 earnings to be sequentially higher as compared with 3QFY18 in view of: i) anticipated higher plant utilisation rate, ii) new business wins, especially for the exterior automotive lighting applications such as Rear Combo Light (RCL) and iii) continuous cost and production optimisation initiatives.

9MFY18 capital expenditure (capex) remained elevated at RM41.2 million, in comparison with 9MFY17 capex of RM41.6 million.

This is in line with management annual capex guidance of up to 12% of revenue. The bulk of the capex was spent on new production equipment, machine upgrades, process automation, new laboratory and quality control equipment and renovation costs.

The group announced first interim dividend of 0.5 sen per share.

We are expecting the group to progressively declare higher dividend, given its healthier cash balance. We are revising downwards FY18 earnings and FY19 earnings by -8% and -5.5% respectively as we assume a more conservative revenue growth rate assumption for the automotive led segment.

We are revising our TP to 86 sen per share. This is premised on FY19 earnings per share of 3.5 sen pegged at unchanged FY19 forward price-earnings ratio (PER) of 25.2 times. Our target PER is based on the group’s two-year historical average low PER.

The shift in focus to automotive LED lighting has greatly improved the group’s earnings growth prospect in recent years.

Premised on new automotive model rollout and advancement in production know-how, we expect the group would be able to consistently expand its profit margin and thus, earnings.

In the immediate term, the demand for exterior automotive LED would pick up at a higher pace as compared to interior automotive LED.

On the longer term, the group’s earnings growth would stem from the increase in adoption of ambient lighting in conjunction with the higher acceptance for autonomous cars.

However, we are anticipating the future earnings growth rate to taper off in view of high base effect. In addition, at current share price, the dividend yield is rather unattractive at approximately 2%. — MIDF Research, Nov 29