Results Highlights

Hartalega’s 1QFY17 net profit fell 10.4% Y.o.Y to RM56.2 mln due to fluctuations in exchange rates and a rise in operational cost from the increase in natural gas prices, maintenance and staff costs. Revenue for the quarter, however, added 25.4% Y.o.Y to RM401.8 mln. The reported revenue came within our expectations, accounting to 24.5% of our full year estimated revenue of RM1.64 bln. The reported earnings, however, came below our expectations, accounting to 19.6% of our previous full year estimated net profit of RM287.0 mln.

Hartalega is operating at an average utilisation rate of 82.0% in 1QFY17, marginally higher than 81.0% recorded in FY16, attributable to the additional new sales secured, coupled with the commencement of Plant 1 & 2 of the NGC. On the flipside, the ASPs of examination glove products remain depressed, owing to the intense competition among glove manufacturers. Consequently, Hartalega’s 1QFY17 EBITDA margin decreased to 21.2%, from 29.6% in the previous corresponding quarter, which was also partly due to higher cost incurred.

On the bottom line, the company’s 1QFY17 net margin contracted to 14.0% (from 19.6%), mainly due to the change in depreciation method from reducing balance to straight line method which has resulted in a decrease in deprecation charge amounting to RM4.4 mln, coupled with a lower effective tax rate from the recognition of tax incentives in several subsidiaries. Meanwhile, the company’s net gearing remained relatively low at 10.6% in 1QFY17 (slightly lower from 10.9% in FY16), underlining the management’s prudence in maintaining a strong balance sheet whilst in the midst of its expansion plans.

Prospects

With the completion of Phase 1 of the NGC, comprising of Plant 1 & 2 at end-February 2016, Hartalega now operates a total of 69 production lines. The company will continue to ramp up its production capacity with the commissioning of Phase 2 of the NGC in August 2016 and production to commence in October 2016.

The Malaysian Rubber Glove Manufacturers Association (MARGMA) has reiterated that the target of 11.0% Y.o.Y export growth in rubber gloves to RM14.5 bln in 2016 is on track, premised on the upbeat global demand for medical gloves (Appendix 1). Going forward, we think that Hartalega’s margins will normalised, given that the company, alongside with its peers in the glove manufacturing industry is scaling back their production capacity expansion. The company also aims to rollout a new product at end-2016. However, no further details were furnished on the new product.

We believe that the recent hike in minimum wages and the rise in natural gas tariff by 5.9%, effective 1st July and 15th July 2016 respectively, will have a minimal impact on Hartalega as the company has been adopting a ‘cost-pass-through’ mechanism, whilst the efficiency of Hartalega’s NCG lines will mitigate the increment in operational costs.

Valuation And Recommendation

Following the weaker-than-expected earnings, we trimmed our earnings estimates for FY17 and FY18 by 3.1% and 7.3% to RM278.1 mln and RM299.8 mln respectively to reflect the general decline in ASPs amid the heightened price competition and volatile exchange rate, but we expect margins to recover in the foreseeable future. Given the recent mild recovery in its share price, we think that the stock now offers limited upside and we reiterate our HOLD recommendation, with an unchanged target price of RM4.25. Our target price remains based on a 30% premium to its peer’s average of 19.2x on its revised FY17 EPS of 17.0 sen.

Still, we believe Hartalega’s share price should command a premium over its peers, premised on: (i) Hartalega’s position as the global market leader in the ever-growing nitrile glove industry, (ii) superior operational efficiency in terms of production speed and number of workers per glove output, and (iii) solid fundamentals where it commands the highest net profit margin vs. its peers.

Risks to our recommendation include rising raw material costs for both natural rubber latex and nitrile latex (both commodity based), which are subject to price fluctuations. Hartalega is exposed to foreign exchange fluctuation risk, given that both its sales and raw material costs are denominated in U.S. Dollars, thus any fluctuations in USD/RM will impact the company’s earnings. Meanwhile, the ever increasing production costs (electricity, gas and labour) will impose a hurdle on its margin expansion, but this will be mitigated by the cost saving measures and the efficiency from the integration of its NCG plants.  

Source: M+ Research Online - 3 Aug 2016