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) instead of PE valuation given uncertain earnings trajectory in the rubber glove industry.

• After an analyst briefing yesterday, we deem Hartalega’s 1QFY24 core earnings of RM2mil (after adding back RM47mil one-off severance payment arising from the decommissioning of Bestari Jaya facility) came in below expectations, accounting for 2% of our earlier FY24F net profit and 0.7% of the streets’.

• We now view that Hartalega could fall back into losses in 2QFY24 vs. our previous expectation that earnings could improve QoQ. This mainly stems from a potential decrease in average selling prices (ASP) due to lower operating costs while sales volume could remain sluggish in 2QFY24 given weak glove demand in 1QCY23 (Exhibit 3).

• Hence, we reverse FY24F earnings of RM74mil to a loss of RM17mil after factoring in a potential decrease in ASP in 2QFY24 due to lower raw material and natural gas prices, bringing FY24F ASP to US$21.1/1K pcs (from US$21.2/1K pcs previously) and a 23% reduction in sales volume assumption caused by a delayed replenishment assumption to 1QCY24 from 3QCY23 previously.

• On a positive note, we project the losses to narrow in 3QFY24 onwards and turn around in 1QFY25, underpinned by cost optimisation from recent decommissioning exercises and customer replenishment cycle in 4QFY24 that could allow Hartalega to regain pricing power.

• In addition, we cut FY25F-26F by 46%/30% mainly due to lower ASP assumptions of US$21.5/1K pcs in FY25F (vs. US$22.4 previously) and US$22.7/1K pcs in FY26F (vs. US$23.4 previously) together with lower sales volume estimates.

• No interim dividend has been declared in 1QFY24, which is in line with our expectation.

• On a QoQ basis, Hartalega’s 1QFY24 core earnings fell 78% to RM2mil from RM7mil in 4QFY23. The deterioration was mainly due to tax expenses of RM6mil compared to a tax benefit of RM22mil in 4QFY23.

• Hartalega’s 1QFY24 ASP was US$22-24/1K pcs vs. US$19- 21/1K pcs in 4QFY24, primarily caused by passing on higher raw material and natural gas prices to customers. However, the group indicated that there could be an ASP decrease in 2QFY24 to reflect lower raw material and natural gas costs.

• Based on our estimates, Hartalega raised ASP in 1QFY24 by 15% QoQ, which is in tandem with the 15% QoQ increase of both raw material and natural gas costs per 1K pcs. However, we note that ASP increase wholly impacts revenue, assuming volume to remain constant, while the decrease of raw material and natural gas costs will only save 45-50% of the COSG/1K pcs, assuming other cost components to remain constant.

• Hence, we view the potential decrease in ASP in 2QFY24 negatively, as the net effect on core earnings will be on the downside. Nevertheless, we believe the ASP in 2QFY24 will just fall back to US$19-21/1K pcs as in 4QFY24.

• Since 16 Mar 2023, we believe market has priced in the “worst-is-over for ASP” scenario (ie. ASP cannot come down as long as the industry bear loss-making risks), after Top Glove took the lead to increase ASP in Feb 2023 onwards. Therefore, a potential ASP decline that could put glove manufacturers back in the red could dampen the market’s current optimistic outlook.

• Separately, Hartalega’s plant utilisation rate (PU) has decreased to 41% in 1QFY24 (vs. 55% in 4QFY23), following Hartalega’s ASP hike back in Mar 2023 onwards. Based on channel checks, this trend is consistent with other Malaysian glove makers, and we believe that orders have migrated to Chinese players which have not increased ASP materially.

• The stock currently trades at a pricey FY25F PE of 56x, 2.1x 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 Aug 2023