This article first appeared in The Edge Malaysia Weekly on December 18, 2023 - December 24, 2023

D&O Green Technologies Bhd’s headquarters and production facility are located in the Batu Berendam Free Industrial Zone in Melaka.

While the home-grown company may not employ as many workers or have manufacturing facilities as vast as its semiconductor neighbours Infineon Technologies AG and Texas Instruments Inc just down the road, it has definitely made an impact on the global automotive light emitting diode (LED) stage through its 90%-owned subsidiary Dominant Opto Technologies Sdn Bhd (Dominant Malaysia).

The group commands a 7% share of the global automotive LED market. It is currently the fourth-biggest player behind Germany-based Osram, Japan-based Nichia and the Netherlands-based Lumileds and has ambitions to move up the ranking in the future.

“We’re lucky to be in the automotive space because of the current climate commitments that have pushed electric vehicles (EVs) to the forefront. There is a lot of upside for us,” says D&O group managing director Tay Kheng Chiong in an interview with The Edge at his office in Melaka. He is also a director and non-executive deputy chairman of Mega First Corp Bhd (MFCB).

Indeed, with the global push towards EVs via government policies as well as commitments by the automakers themselves, D&O finds itself in a sweet spot, thanks to its early lead in the automotive LED segment.

“Five years ago, a car would only require 500 to 1,200 LEDs. Today, a BMW i7 easily has 1,500 LEDs. It is not just about the growth [of EVs] across the region, but also a structural shift in the way cars are made, where more LEDs are used,” says Tay.

Notably, the red, green and blue (RGB) LEDs found in the interior of the BMW i7 are produced by D&O. Unlike many other semiconductor companies in Malaysia, which are typically contract manufacturers, the group manufactures the LEDs under its own brand.

Tay is not worried about a potential recession slowing the group’s progress as he believes that in good times or bad, the global EV agenda will continue to power ahead given the pledges made by car makers and governments to address the climate change crisis. “As long as the EV agenda moves forward, so will D&O,” he says, adding that there is a lot of excitement for the group moving forward.

SEMI, the global microelectronics industry association, forecasts that between 2023 and 2030, the global semiconductor industry is expected to grow at a compound annual growth rate of 10%, driven by artificial intelligence (AI), automotive and industrial applications, 5G, high-performance computing and edge computing.

Tay sees D&O’s smart LED segment growing rapidly in the next few years. Smart LEDs are those that have an integrated circuit and LED embedded in a single package.

“The next stage in automotive LED technology is system integrated packages. Our smart LED is the beginning of that, where you can integrate more functions and solutions into the LED. The solution of the whole system will be simpler in the future, especially with EVs,” he explains.

BMW’s iX series was D&O’s big break in the smart LED segment. Tay notes that the product has actually been many years in the making since the German marque approached the group to manufacture smart LEDs back in 2015.

The smart LED segment currently makes up a negligible portion of D&O’s sales revenue, but the group expects its contribution to increase to 15% of its sales revenue by 2025.

In a Dec 5 report, PublicInvest Research says D&O’s smart LED sales volume is expected to surge more than 140% year on year (y-o-y) to 85 million units in 2024, accounting for 6% of its FY2024 sales forecast.

“D&O’s smart LED has been successfully qualified by another German automaker. As more car makers are shifting to EVs, smart LED is expected to see strong demand in the coming years as it reduces the connectivity in the car by up to 50%, which can help reduce power consumption and fits well into the definition of the energy-friendly EV concept,” says the research house.

D&O has undoubtedly worked hard to get to where it is today. It invests heavily in research and development (R&D) and keeps abreast of market trends to make sure it is in tune with its key customers.

Tay believes the marketing function of the group is a crucial part in finding out what customers want and it is from there that R&D can take place to cater to those needs. D&O has regional sales offices in seven countries and employs more than 2,700 people.

“Gone are the days when the R&D department develops a product and then tries to sell it to customers. These days, customers are so proficient that you need to know what they want before working out with the R&D department on whether you can create distinctive features for the customer,” he says.

“We spend about 4% of our revenue on R&D. If we have more money, we will spend more because it will help accelerate our pace to move up the ranks. We are in the technology industry and it is expensive because it’s not just about R&D in products, but in materials as well as areas like failure analysis labs and reliability labs. The investment is huge.”

Typically, the gestation period for a first-of-its-kind product, such as the smart LED, is about five years. “The process cannot be rushed,” he adds.

Tay points out that it is normal to encounter hiccups at the beginning stages of mass production and calls it the “tuition fee” the group has to pay to get it right. “This is why the barrier to entry is high in this business — not anyone who wants to do it can get it done.”

D&O’s business model hinges on differentiation and the group is always on the lookout for what Tay calls a “distinctive feature” in order to stand out from its competitors. It is one of two global automotive LED manufacturers that offer a full range of colour spectrum and brightness intensity catering for both interior and exterior applications for automobiles.

“It is either cost leadership or differentiation, you cannot be in between. As we are in a small country without the market size, we have to focus on differentiation. Our product needs to be different and distinctive in terms of brightness and features,” says Tay.

About 99% of D&O’s revenue is derived from the automotive industry outside of Malaysia. It serves about 101 customers, 15% of which contribute about 70% to the group’s revenue.

Tay says the group is aware that it also has to pay attention to its smaller customers because it is from this pool of auto manufacturers that some will turn into big contributors to its revenue one day. “About 5% of them will move into the top 15% of customers, so we need to make sure that we take care of these customers, especially those in China, because new players are emerging rapidly.”

Nevertheless, Tay is not interested in capturing a slice of the pie that is all the different brands of Chinese car makers — there are more than 70 of them — as he believes many of them will not be able to withstand the competition.

“The nature of China is such that it starts out crowded and then it starts to streamline. We need to be careful not to trap ourselves there because once these companies close shop, you won’t be able to get your money and payment will become an issue,” he says.

For the first half of the year ended June 30 (1HFY2023), D&O’s financial performance was weak, impacted by slow demand from China. Its net profit stood at RM1.58 million on revenue of RM434.69 million. This compares with a net profit of RM45.83 million on revenue of RM483.67 million a year earlier.

The group experienced overcapacity during that period as the typical surge in orders that usually happens at the end of the year did not occur in 2022 due to the prolonged lockdown in China.

Plant utilisation was at 75% in 1HFY2023. As the group’s gross margin fell to just 16% in 1HFY2023 from 28% a year earlier, its net profit was also impacted. However, based on its financial performance in 3QFY2023, things seem to be recovering.

The group’s revenue for 9MFY2023 amounted to RM706.64 million, slightly less than the RM735.83 million it achieved a year earlier. Net profit was weaker by 67%, recording RM19.82 million compared with RM61.59 million in the previous corresponding period. The weaker net profit was a result of the weak earnings in 1HFY2023 as it was not able to achieve economies of scale with the lower plant utilisation.

In 3QFY2023, the plant utilisation improved to 81% and Tay sees it hitting almost 90% in 4QFY2023. This means its gross margin will improve significantly given the improved utilisation rate in the second half of the year.

“Economies of scale play an important role in catching up on the margin gap. Margin performance is highly dependent on the utilisation rate,” he says.

For the full year 2023, Tay hints that revenue is likely to exceed the RM983.02 million achieved in 2022. “In fact, we foresee that we will achieve record revenue in 4QFY2023. The gross margin for 4QFY2023 will reach 26% to 27%,” he says.

PublicInvest Research estimates FY2023 revenue to come in at RM1.03 billion while core net profit is projected to be RM57.9 million. The research house believes D&O’s gross margin should normalise to the 27%-28% range in FY2024 compared with an estimated 21% this year, underpinned by an improvement in capacity utilisation, better margins from smart LEDs and headlamps, and higher productivity with more automation in place.

Tay says it is impossible for plants like that of D&O to be fully automated because of its high product mix. “We have about 7,000 to 8,000 parts. It is not possible to be fully automated but we use a lot of Industry 4.0 to automate individual processes.”

Asked if it has ever crossed his mind to set up operations elsewhere, Tay says Malaysia is the best place for the semiconductor industry.

“Malaysia is the best. There is no other place like this in the region because we have the best ecosystem for back-end semiconductors, which has been around for more than 50 years. You can’t find it even in our neighbouring countries,” says the 59-year-old.

Interestingly, while D&O’s peers in Penang have a shortage of talent, it is not an issue in Melaka, says Tay. “We have several universities here that produce good graduates,” he adds.

With the two multinational semiconductor companies just a stone’s throw from D&O, Tay says it does have to try to boost its remuneration package by other means to attract talent. But he is aware that the group cannot compete with MNCs in terms of salaries.

“We can complement the salary but not compete because if we were to raise the salaries of our employees, the MNCs would just put out a better offer. Fortunately, we have an ESOS (employee share option scheme) to help us complement the salary,” he says.

The biggest challenge is all the unpredictable events, Tay opines. However, he believes this is just part and parcel of doing business. “As long as you have your own space, make it the best. That’s the only way.”

Notably, D&O’s largest shareholder is MFCB executive chairman Goh Nan Kioh, with a 30.3% stake as at March 31, 2023.

D&O’s share price had shed 16.9% over the past year to close at RM3.55 last Thursday. This values the group at RM4.4 billion.

In terms of price-earnings ratio, D&O is trading at a trailing 12-month PER of 140.94 times — one of the highest in the technology sector. Based on Bloomberg consensus, it has a forward PER of 83.26 times.

According to Bloomberg data, there are currently three “buy”, two “hold” and one “sell” calls on D&O, with an average target price of RM3.62. PublicInvest Research has the highest target price at RM4.37 while Kenanga Research has the lowest at RM2.30. 

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