Results Highlights

• Hartalega’s 3QFY17 net profit saw a 9.0% Y.o.Y drop to RM66.2 mln, from RM72.8 mln in the previous corresponding quarter – mainly due to the recognition of an unrealised forex loss on the revaluation of a loan denominated in the U.S. Dollar, as well as a fair value loss on foreign currency forward contracts. Quarterly revenue however, jumped 14.6% Y.o.Y to RM456.3 mln, from RM398.0 mln in 3QFY16.

• Cumulative 9MFY17 net profit fell slightly by 1.2% Y.o.Y to RM193.6 mln against RM195.9 mln in 9MFY16, dragged down by the aforementioned reasons, albeit revenue grew 18.0% Y.o.Y to RM1.30 bln from RM1.10 bln in the similar period a year earlier. The reported earnings and revenue were below our expectations - accounting to only 63.6% of our previous FY17 estimated net profit of RM304.2 mln and 70.2% of our previous FY17 revenue of RM1.85 bln.

• Hartalega is running at an average utilisation rate of 86.0% in 3QFY17, slightly down from the 88.0% utilisation rate registered in the previous quarter, following the commencement of new production lines at the NGC. Meanwhile, ASP was higher compared to 2QFY17, as the group was able to pass on the higher cost of raw materials to its customers.

• On the bottom line, quarterly net margin fell to 14.5% (vs 18.3% in 3QFY16), mainly due to the recognition of an unrealised forex loss arising from the revaluation of a U.S. Dollar denominated loan.

Prospects

Following the completion of Phase 1 of the NGC, comprising of Plant 1 & 2 last year, Hartalega is on track to complete the construction of its Plant 3, with five new production lines already operational. Cumulatively, the group is operating a total of 72 production lines at an utilisation rate of 86.0% (from 88.0% in the last quarter).

Going forward, we think that the price of rubber is expected to be costlier on the back of the sharp appreciation in natural rubber prices due to increased rainfall and floods locally (i.e.: Kelantan, Pahang and Johor), which is expected to persist until March, as well as in Thailand. Raw materials for nitrile medical gloves are also expected to spike up amid higher synthetic latex and butadiene (key ingredient for nitrile rubber gloves) prices. Butadiene is the main ingredient used to make car tires, which saw an increase in demand in the recent months due to surging car sales in China.

Consequently, Hartalega is expected to increase its ASP again, in-tandem with the mounting costs of production. Still, we think that margins could be pressured moving forward, despite a ‘cost-pass through’ policy adopted by the group, mainly due to competitive pricing amid rising supply of nitrile rubber gloves by other rubber manufacturers. However, we remain positive on Hartalega’s outlook, banking on the strengthening U.S. Dollar and growing demand for nitrile medical gloves. The Malaysian Rubber Glove Manufacturers Association (Margma) has forecast an 8.0%-to-10.0% growth in the demand for rubber gloves in 2017.

Valuation and Recommendation

Following Hartalega’s lower-than-expected earnings, we trimmed our earnings estimates for FY17 and FY18 by 14.9% and 4.4% to RM264.7 mln and RM319.4 mln respectively to reflect the competitive environment of the rubber gloves industry, amid rising cost of raw materials, labour and utilities.

Nevertheless, with the strengthening U.S. Dollar, higher economies of scale following Hartalega’s production expansion, higher capacity utilisation rate and continuous cost management by the group, we maintain our HOLD recommendation on Hartalega with lower target price of RM4.90 (from RM5.00).

Our target price is based on a 25.0% (from 30.0%) premium to its peers’ average PER of 20.0x (from 19.0x in-tandem with an industry-wide decline in earnings) on its revised FY18 (unchanged) EPS of 19.5 sen. Meanwhile, the premium over its peer average was reduced from 30.0% to 25.0% in-view of the increasing industry-wide nitrile glove output, although Hartalega remains a lead player in the nitrile glove industry due to its superior operational efficiency and 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: Mplus Research - 16 Feb 2017