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 is based on a FY24F P/BV of 1x (1.5 standard deviation below 10-year average) from PE valuation given volatile earnings in the rubber glove industry.

• Hartalega’s FY23 core net profit of RM114mil (after adding back RM347mil one-off asset impairments from the decommissioning of Bestari Jaya facility) beat expectations, coming in 8.7x above our forecast and 1.9x above consensus. The deviation was primarily attributed to higher-than-expected plant utilisation rate (PU) and lower operating expenses.

• However, we cut FY24F-25F earnings by 59%/28% mainly due to lower average selling price (ASP) assumptions of US$21.2/1K pcs in FY24F (vs US$22.1 previously) and US$22.4/1K pcs in FY25F (vs US$23.1 previously) together with lower sales volume estimates. We also introduce FY26F earnings with a growth of 41% premised on a higher ASP of US$23.4/1K pcs and PU of 84%.

• No interim dividend has been declared in FY23, which is in line with our expectation.

• Hartalega turned around to a 4QFY23 core net profit of RM7mil from core loss of RM34mil in 3QFY23. The improvement was mainly due to a 12% QoQ increase in revenue.

• Despite a 10% QoQ decline in ASP, the majority of revenue growth was underpinned by a 30% QoQ increase in sales volume. The profit was enhanced by lower operating expenses as a result of higher economies of scale.

• Hartalega’s 4QFY23 blended ASP was US$19.4-21.4/1K pcs, in line with the guidance by Hartalega in Feb 2023 briefing. Hartalega guided that 1QFY24F ASP will be just marginally higher than 4QFY23 (<5%), mainly due to strong resistance from customers.

• Given the low PU (<50%) in Malaysian glove industry, we strongly believe that PU improvement should precede any meaningful ASP hike. On a positive note, there is no longer any downward pressure from current ASP of US$20/1K pieces, as Chinese glovemakers have increased ASPs from US$14-15/1K pcs to US$16-17/1K pcs since March 2023, which remained stable since then. Notably, Chinese gloves are US$3-4/1K pcs cheaper than Malaysia’s.

• In terms of PU, Hartalega was running at 55% in 4QFY23 (vs 44% in 3QFY23). We gathered that this was due to Chinese glovemakers closing capacity during Chinese New Year holidays amid increased demand from the food industry for replenishment after the festive season. However, the group indicated that PU may be lower in 1QFY24F as a result of recent ASP increase.

• This could imply rubber glove distributors still have inventories and poses a risk that they still have the discretion to delay replenishment longer or even later than our assumption by 3Q2023.

• Hartalega clarifies that the primary reason for decommissioning the Bestari Jaya facility is to transfer orders to the more efficient Next Generation Integrated Glove Manufacturing Complex (NGC) in Sepang, in order to compete with Chinese glovemakers from a cost perspective amid uncertain impact from an ASP increase.

• Given NGC’s cutting-edge production lines, we believe that the COGS/1K pcs could decrease by US$1-1.5/1K pcs to US$20/1K pcs from current US$21/1K pcs (not accounting for natural gas price moderation).

• Based on our assumptions, the gradual recovery of rubber glove demand beginning in 3Q2022 will be supported by the commissioning of 2 factories in NGC 1.5 with a capacity of 9.5bil pcs/annum by end-2023 or early 2024.

• In our sector report on 18 April 2023, we acknowledge glovemakers’ earnings/losses will improve gradually over time, thanks to moderating natural gas prices and lower operating expenses especially for Hartalega with NGC’s more efficient production lines.

• Even so, the stock currently trades at a pricey FY25F PE of 32x, 23% above its 10-year average of 26x with minimal FY24F dividend yield. Hence, we advocate investors to take profit at this juncture.

Source: AmInvest Research - 10 May 2023