Investment Highlights

• We upgrade Hartalega Holdings (Hartalega) to BUY from SELL previously with a higher fair value (FV) of RM2.80/share (from RM1.40/share previously), which incorporates a 3% premium to reflect an unchanged ESG rating of 4-star.

• Our valuation is based on a CY25F PE of 26x, at parity to Harta’s 10-year average, revised from P/BV methodology given that Hartalega could register sustainable earnings in the coming years. Our re-rating is underpinned by both fundamental and fund flow factors:
  (a) Fundamental: Achieved a better-than-anticipated 1HFY24 result with 2 consecutive QoQ improvement in core EBIT (Exhibit 1). Hartalega further guided for sales volume to improve in the coming quarters with a target to achieve a 30% increase to 6bil pcs in 4QFY24 from 4.6bil pcs in 2QFY24, which could provide additional economies of scale despite a lower pricing environment. 
  (b) Fund Flow: Hartalega distinguishes itself as the lowestcost Malaysian glove-maker among local peers (Exhibit 2), suggesting that the group will be the first to benefit from any demand recovery and deliver pre-pandemic profit for a full financial year. We are confident that this will convince investors to value Hartalega at a premium with a rolledforward CY25F. 
  Our investment thesis does not account for Chinese players expanding capacity irrationally and further depressing average selling prices (ASP).
• Hartalega’s 1HFY24 core earnings of RM27.6mil (after adding back a one-off severance payment of RM47mil arising from the decommissioning of Bestari Jaya facility in 1QFY24) came in above our earlier expectation, as we forecasted an earlier FY24F core loss of RM17mil. Similarly, the result was above street estimates, accounting for 81% of consensus’ FY24F profit of RM33.9mil.
• The positive deviation was mainly attributable to higher revenue, lower raw material prices and cost savings primarily from the decommissioning of the less-efficient Bestari Jaya facility.

• Hence, we reversed FY24F into a profit of RM94mil mainly to account for the lower cost structure and higher sales volume. In addition, we raised FY25F-26F earnings to RM263mil/RM406mil from RM129mil/RM237mil after factoring in lower cost structure and higher sales volume. We maintain our assumption for the inventory replenishment cycle to begin in 1QCY24.

• We project Hartalega’s earnings to continuously improve on a QoQ basis, underpinned by a lower cost structure as a result of economies of scale and customer replenishment cycle early next year that could allow Hartalega to regain pricing power to offset the potential increase in natural gas cost.

• No interim dividend has been declared in 2QFY24, which is in line with our earlier expectation. In tandem with higher earnings projections, we introduced DPS of 2.0sen for FY24F and increased FY25F-26F DPS to 5.0sen/7.0sen from 2.0sen/4.0sen.

• On a QoQ basis, Hartalega’s 2QFY24 core earnings improved 17x to RM26mil from RM2mil in 1QFY24, despite ASP declining by 7%. The improvement was mainly due to an improvement in sales volume, lower raw material prices and cost savings from Bestari Jaya facility. We estimate that Hartalega’s PATAMI breakeven costs improved to US$20/1K pcs from US$22-23/1K pcs in 1QFY24 (Exhibit 2).

• Hartalega’s 2QFY24 ASP was US$21-22/1K pcs vs. US$22-24/1K pcs in 1QFY24. The decrease was due primarily to lower raw material prices and pricing pressure from Chinese players. Going into 3QFY24, ASP continues to face downside risks as Chinese players have not increased prices yet despite running at full plant utilisation rates (PU) for nitrile medical glvoes. For now, Chinese peers are still selling at US$14-15/1K pcs, which implies a discount of US$2-3/1K pcs compared to Malaysia.

• Separately, Hartalega’s PU has improved to 44% in 2QFY24 vs. 41% in 1QFY24. Going into 3QFY23F, PU will be better QoQ, as customers encounter depleting inventories amid Chinese competitors operating at maximum output. Based on channel checks, this trend is consistent with other Malaysian glove makers in 4QCY23.

• All in, the stock currently trades at an attractive CY25F PE of 22x, at 15% discount to its 10-year average of 26x.

Source: AmInvest Research - 8 Nov 2023