Investment Highlights

• We downgrade Hartalega Holdings (Hartalega) to SELL from HOLD previously after the share price spiked 26% over the past 3 weeks despite weak fundamentals. Nevertheless, we maintain our fair value (FV) of RM1.40/share, which incorporates a 3% premium to reflect our unchanged ESG rating of 4 stars. Our valuation is based on FY24F PE of 26x, at parity to its 10-year average.

• We cut FY23F earnings by 82% mainly attributable to higherthan-expected operating costs, particularly natural gas price and electricity tariff. Nevertheless, our FY24F-25F earnings are unchanged for now as we continue to closely monitor end-clients inventory replenishment and average selling price (ASP) movements.

• From the plant visit, we gathered that plant utilisation rate (PU) increased from 42% in 3QFY23 to 50% in Jan-Feb 2023. The PU improvement is consistent with Top Glove Corporation’s (Top Glove) 6% increase in 2QFY23 sales volume.

• The improved PU for the industry could imply customers are beginning to replenish their depleting inventories after overbuying in 2021. However, we remain cautious and prefer to observe for another quarter (ie. 2QCY23F) amid a volatile market. Even so, we have already assumed an inventory replenishment cycle to commence in 3QCY23F.

• Separately, Hartalega successfully increased ASP for medical nitrile rubber gloves by US$0.70/1K pcs (+<5%) between Mar and Apr 2023, from US$18-19/1K pcs to US$19- 20/1K pcs. This is in line with Top Glove’s guidance on an ASP increase in Mar-May 2023 from its Mar briefing. Notably, the ASPs have been declining since 2QFY22.

• Based on channel checks, Chinese glove makers have increased ASPs from as low as US$14-15/1K pcs to US$16- 17/1K pcs (inclusive 7.5% US-tariff) in similar period.

• However, not all customers accepted the ASP increase, causing Hartalega’s PU to dip slightly to 47%-48% in Mar-Apr 2023, albeit still higher than 42% in 2QFY23. Amid weak demand, we opine that ASPs could remain volatile until 3QCY23F, when a meaningful inventory replenishment cycle is more likely to happen.

• On a QoQ basis, the cost/1K pcs increased by US$2 in JanMar 2023, mostly due to higher natural gas prices (+15%) and electricity tariff (+5.4x), as compared to an ASP increase of US$0.35/1K pcs in Mar 2023. On a positive note, natural gas prices are expected to decrease by 15% (translating to US$0.30/1K pcs) in 2QCY23F, suggesting that losses will narrow in 2QCY23 onwards.

• In the past 3 weeks, Hartalega’s share price has increased by 27%, despite FY24F financial performance remaining weak. While losses are likely to narrow, our forecasted earnings cannot yet support the current high valuation.

• The stock currently trades at a FY24F PE of 37x, which is 42% above its 10-year average of 26x with no dividend prospects for this year. Hence, we advocate investors to take profit at this juncture.

Source: AmInvest Research - 6 Apr 2023