Investment Highlights

• We maintain SELL on Hartalega Holdings (Hartalega) with an unchanged fair value (FV) of RM1.40/share, which incorporates a 3% premium to reflect an unchanged ESG rating of 4 stars. Our valuation basis remains on a FY24F PE of 26x, at parity to its 10- year average.

• We maintain FY23F core earnings of RM13mil despite the oneoff decommission-related impairment loss of RM347mil that will be recognised in 4QFY23 result, which will be announced later today. Likewise, our FY24F-25F earnings are unchanged for now pending the result and analyst briefing today.

• Yesterday, Hartalega announced the decommissioning of its Bestari Jaya facility (Bestari) (Exhibit 1) and consolidation of operations at the Next Generation Integrated Glove Manufacturing Complex (NGC) in Sepang. The decommissioning process is expected to last 6 months until end-CY2023.

• Bestari’s current capacity is 13bil pcs/annum supported by 4 production plants with 40 production lines. Hence, the decommissioning exercise will eliminate 30% of the group’s overall capacity of 44bil pcs/annum.

• In addition to the 4QFY23 impairment loss, there will be another one-off RM70mil in retrenchment costs and contract obligation expenses in FY2024F.

• In contrast to NGC’s cutting-edge production lines, Bestari’s operation is less efficient owing to older technology. NGC operates at 388mil pcs/line/annum while Bestari operates at 325mil pcs/line/annum. This results in higher energy, labour, and maintenance expenses for Bestari.

• Therefore, once decommissioning is completed, the group expects a reduction in operating expenses and depreciation, which could help mitigate the average selling price (ASP) discount of US$3-4/1K pcs currently quoted by Chinese glovemakers. However, the quantum is subject to clarification in the briefing today.

• In our view, this large-scale 30% decommissioning implies that Hartalega does not foresee a meaningful return of glove demand in the immediate future. Furthermore, this could mean that local and regional glovemakers should engage in massive decommissioning together to restore supply-demand equilibrium.

• Even so, China's response is of greater concern, as we learned of the negative response to 1 of the 4 largest Malaysian glove manufacturers which attempted to negotiate with Intco Medical Technology (Intco) in late 2022 regarding the deteriorating ASP.

• Given the existing plant utilisation rate assumptions of 70% in FY24F and 85% in FY25F, the 30% decommission exercise could have a minimal FY24F impact but reduce FY25F core earnings by 27% (assuming no new capacities and synergies), according to our sensitivity analysis. However, we do not discount that management could meet stronger FY25F demand by commissioning NGC 1.5.

• The stock currently trades at a FY24F PE of 36x, which is 38% 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 - 9 May 2023