Investment Highlights

• We reiterate BUY on Hartalega Holdings (Hartalega) with an unchanged fair value (FV) of RM3.20/share, based on CY25F target PE of 30x (0.25x standard deviation (SD) above 10-year average of 27x). Our FV incorporates a 3% premium to reflect an unchanged ESG rating of 4-star.

• Hartalega’s 9MFY24 core earnings of RM28mil (after excluding a one-off severance payment of RM47mil recognised in 1QFY24 and RM20mil reversal of severance compensation in 3QFY24) fell short of our expectation due mainly to lower deliveries as a result of Red Sea-related shipment delays, impacting 600mil pcs (13% of 3QFY24 sales volume). However, the result was within street’s estimate.

• Assuming the 600mil pcs rubber gloves were sold at US$19- 20/1K pcs (3QFY24 prices) and variable costs (ie. raw material, packaging, chemicals and distribution expenses) at 40% of revenue (similar to 3QFY24 cost structure), we estimate the PBT loss due to the Red Sea disruption at RM30mil in 3QFY24. This implies an adjusted 3QFY24 PBT of RM38mil, mildly higher than RM34mil in 2QFY24 and our earlier forecast.

• Nevertheless, we cut FY24F core net profit by 34% to RM62mil from RM93mil to reflect the Red Sea-related impact in 3QFY24 and longer time to scale up production in 4QFY24F. However, we maintain FY25F-26F earnings, supported by our unchanged assumption for the inventory replenishment cycle to begin in 1QCY24 and a more efficient cost structure following Bestari Jaya's complete decommissioning by the end of FY24F.

• Going into 4QFY24F, we project Hartalega’s QoQ earnings to be stronger, underpinned by a roll-over of 600mil pcs rubber gloves, commencement of the inventory replenishment cycle and lower cost structure, assuming no unforeseen disruptions from the Red Sea crisis.

• Hartalega deteriorated to a breakeven position of RM1mil in 3QFY24, compared to a core net profit of RM26mil in 2QFY24. Sequentially, this mainly stemmed from lower average selling prices (ASP) (-7%) and sales volume (-3%) coupled with higher raw material prices (+12%).

• Hartalega’s 3QFY24 ASP was US$19-20/1K pcs vs. US$21- 22/1K pcs in 2QFY24. The decrease was due primarily to pricing pressure from Chinese players despite rising raw material prices. This is consistent with Hartalega’s guidance in the previous analyst briefing back in Nov 2023.

• Going into 4QFY24F, management guided that the group is capable of increasing ASP to fully pass on higher operating costs eg. raw materials and natural gas.

• In Jan 2024, Chinese peers are still selling 3.0-3.5g nitrile rubber medical gloves at US$14-15/1K pcs, which implies a discount of US$2/1K pcs compared to Malaysia’s US$16-17.

• Separately, Hartalega’s plant utilisation (PU) has been flattish QoQ at 43% in 3QFY24. Barring unforeseen disruptions from Red Sea crisis, the group anticipates a better QoQ PU in 4QFY24F. The group is targeting for a 10% increase in sales volume to 5bil pcs from 4.5bil pcs in 3QFY24, as customers could face depleting inventories even though Chinese competitors are operating at maximum output. This trend is consistent with other Malaysian glove makers in 4QFY24F, based on channel checks.

• Notably, Hartalega’s 3QFY24 PBT breakeven remained flattish QoQ at US$19.4/1K pcs, compared to US$19.6/1K pcs in 2QFY24 amid rising raw material prices and lower sales volume.

• No interim dividend has been declared in 3QFY24, which is in line with our earlier expectation. In tandem with earnings adjustment for FY24F, we trimmed FY24F DPS to 1.0sen from 2.0sen.

• All in, the stock currently still trades at an attractive CY25F PE of 25x, at 26% discount to its pre-pandemic average of 34x.

Source: AmInvest Research - 7 Feb 2024