Results Highlights

• Hartalega posted a 45.3% Y.o.Y jump in its 4QFY17 net profit to RM89.4 mln, from RM61.6 mln in the previous corresponding quarter, in-tandem with a 31.6% Y.o.Y jump in revenue to RM527.0 mln vs. RM400.5 mln in 4QFY16. The stronger earnings also emanated from greater operational efficiency and lower overheads. The group has also declared a third interim dividend of two sen per share, payable on 23th June 2017.

• Full year net profit, meanwhile, rose 10.0% Y.o.Y to RM283.0 mln, from RM257.4 mln in the previous corresponding year – led by improvements in sales revenue and a stronger U.S. Dollar. The reported earnings and revenue were within our expectations - accounting to 105.5% of our FY17 estimated net profit of RM283.0 mln and 102.7% of our FY17 revenue forecast of RM1.82 bln.

• Hartalega’s NGC plant expansion plans are progressing smoothly, with seven of the twelve production lines in Plant 3 successfully commissioned in FY17. Going forward, the group is expected to commission the remaining lines in Plant 3 in FY18, followed by the commissioning of production lines in Plant 4. Cumulatively, Hartalega is operating 76 lines in its manufacturing plants, running at a higher average utilisation rate of 87.0% (from 81.0% in FY16).

• Going forward, Hartalega’s earnings growth will be underpinned by higher sales volume, normalising raw material prices, resilient global demand growth for rubber gloves and its ongoing cost management strategies

Prospects

With Plant 3 expected to be fully commissioned in FY18, followed by the commissioning of Plant 4, we remain sanguine that the additional capacity can be adequately absorbed by the market, banking on an 8% - 10% per annum growth in the global demand for rubber gloves (Source: MARGMA).

In terms of efficiency, Hartalega achieved an average utilisation rate of 87.0%, up 6.0% Y.o.Y from 81.0% in FY16. The improved utilisation rate could be attributed to: (i) robust global demand for rubber medical gloves, (ii) progressive capacity expansion to avoid a supply glut, and (iii) competitive pricing, coupled with sustained quality service to ensure customer loyalty. We expect its efficiency to further improve, moving forward, in-line with the group’s continual cost management strategies.

Hartalega’s 4QFY17 net profit margin expanded to 17.0% (from 15.4% in 4QFY16), following an industry-wide ASP hike amid mounting input cost pressures. In the nearterm, however, we think that raw material prices will begin to normalise after coming off its recent high on: (i) falling demand of butadiene which saw a spike in prices in 4Q2016 due to a sharp rise in car sales in China, (ii) anticipated recovery in Thailand’s rubber output as trees planted between 2005 and 2008 hit peak production yields, (iii) weaker Greenback, and (iv) lower crude oil prices. On the flipside, weather-related supply constraints like flash floods and dry winter season (from February to May) in Thailand, Malaysia and Indonesia could limit the downside of rubber prices.

Consequently, we forecast higher earnings prospects for the group, underpinned by increased sales volume, greater operational efficiencies and robust demand for rubber gloves due to the ageing population. Its bottomline will also be lifted by lower tax rates (between 15%-19%) in the coming quarters, due to the availability of reinvestment allowance incentives.

Valuation and Recommendation

Although the group’s full year earnings were largely within our estimates, we tweaked our earnings estimate for FY18 higher by 11.1% to RM362.8 mln after taking into account higher ASP amid the rising input costs, sustained demand for global medical gloves and Hartalega’s progressive capacity expansion. We also introduce our earnings estimates for FY19 with a net profit forecast of RM389.3 mln.

We maintain our HOLD recommendation on Hartalega with higher target price of RM5.75 (from RM5.00). Despite the higher target price, our recommendation is maintained as its recent share price gains have largely reflected its positives, which includes expectation of higher sales volumes, in-line with Hartalega’s capacity expansion and superior operational efficiency.

Our target price is arrived at ascribing a higher target PER of 30.0x (from 25.0x) to its revised FY18 EPS of 22.1 sen, which continues to be higher than its peer average of 20.0x. We think the higher target PER is appropriate premised on: (i) Hartalega’s position as the global market leader in the growing nitrile glove industry, (ii) superior operational efficiency in terms of production speed and the lower number of workers per glove output, as well as (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 the U.S. Dollar, 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 - 12 May 2017