Investment Highlights

• We maintain our HOLD recommendation with an unchanged FV of RM5.88/share. Our fair value for Hartalega is based on DCF, which has a WACC of 7.3% and terminal growth of 2.5%. At our fair value of RM5.88/share, the implied CY19F P/E is 32.8x.

• We like Hartalega for its foresight and execution, visible capacity expansion and product innovation. However, we believe the market has priced in the potential earnings delivery as the company is currently trading at 44.9x P/E, which is 1.5SD above its historical P/E.

• We recently visited Hartalega’s Next Generation Complex (NGC) in Sepang to observe the operations of its Plant 1 which runs at 45,000 pcs/hour. Encouragingly, Hartalega is making continuous efforts in improving the average speed of all its installed lines. We observed that the lines were smoothly linked from start to its packing stations to ensure increased efficiency.

• The company is advocating anti-microbial gloves (AMG) to be the new industry standard. AMGs are better than conventional medical gloves as these help to reduce the risk of infection. The AMG production can easily be incorporated into its production line by integrating the special dye into the existing production process.

• The additional costs pertaining to the patented dye will be passed on to customers, but the company plans to price it competitively to encourage the initial take-up rate. Hartalega is also seeking the approval of the US Federal Drug Administration (FDA) to enter the US market which takes up over half of Hartalega’s business. The company owns exclusive rights for the application of the patented anti-microbial technology on gloves.

• The push for AMG is in line with the company’s efforts to stay competitive. The demand for nitrile gloves has declined as reflected in the 3.5% QoQ drop in sales volume in its latest financial results. This is due to increased competition from the ramp-up of capacity expansion by other major players such as Top Glove and Kossan.

• Also, the market demand for nitrile has normalized as vinyl glove production has resumed in China. Recall that previously, Hartalega benefitted from the temporary rise in the ASP of vinyl gloves, which came close to the higherquality nitrile gloves’ ASP. As a result, customers switched from vinyl gloves to nitrile gloves.

• Moving forward, we believe the company will be able to achieve a sales volume of 30bil in FY19F in tandem with the expected global rubber gloves demand of circa 10%.
• Although the ASP of circa US$24 per thousand pieces has improved 10.8% YoY, this may not be sustainable. Downward pressure could come from heightened competition and the potential price correction from lower input costs.

• In spite of this, we believe that Hartalega would be able to maintain its margins due to the decline in the cost of butadiene, an input for nitrile latex. This will boost margins temporarily before the cost pass-through mechanism kicks in.

Source: AmInvest Research - 27 Nov 2018