• Hartalega’s 1QFY18 net profit jumped 71.6% Y.o.Y to RM96.4 mln, from RM56.2 mln in the previous corresponding quarter, on the back of a 49.6% Y.o.Y surge in revenue to RM601.0 mln against RM401.8 mln in 1QFY17. The stellar earnings growth was also attributed to higher ASPs, stronger U.S. Dollar as well as increased operational efficiency. No dividend was declared by Hartalega for the quarter under review.

• The group is currently operating 81 production lines in both the NGC and Bestari Jaya plants, running at a high production rate of 91.0% as at 1QFY18. We expect the group to churn out about 3.94 bln more rubber gloves moving forward, as it begins to commission the production lines in Plant 4 from August 2017.

• The production lines at Plant 4 are slated to be commissioned at a rate of two lines per month (previously one line per month) until 1Q2018. We think that the higher commissioning rate reflects Hartalega’s initiatives to cater to the growing demand for medical rubber gloves in the regional markets (i.e: China and India). The current per capita consumption of medical gloves in China is only about three pairs per year, compared to Malaysia where a single user consumes about 10 pairs per year – indicating significant potential for regional expansion.

• Going forward, we think that Hartalega’s earnings growth prospect (5-year CAGR: 17.9%) will be underpinned by higher sales orders, improved margins due to higher ASPs and strong operational efficiencies.

Prospects

Moving forward, Hartalega will continue to progressively expand its production capacity at the NGC to about 28.2 bln gloves upon completion. Plant 4 is expected to be commissioned in August this year and will add about 3.94 bln pieces of gloves to production in FY18, following its completion in 1Q2018, in our view.

In terms of efficiency, Hartalega’s average utilisation rate jumped to 91.0%, up 9.0% Y.o.Y from 82.0% in 1QFY17. Historically, the group’s production rate stood at about 81.0% - 88.0% over the past three financial years. The higher utilisation rate could be attributed to: (i) stronger demand for rubber medical gloves worldwide, (ii) higher sales orders and (iii) effective quality control.

Hartalega’s 1QFY18 net profit margin rose 2.0% Y.o.Y to 16.0% (from 14% in 1QFY17), driven by stronger revenue contribution, higher operational efficiency in-tandem with the group’s efforts to increase automation and higher ASPs, coupled with a stronger Greenback. Subsequently, we expect Hartalega to maintain a strong growth trajectory (+15.0%-44.0%) in FY18 to FY19, underpinned by: (i) resilient demand for nitrile gloves amid the recovery in the global growth outlook, (ii) higher ASPs and (iii) progressive capacity expansion, which will boost sales volume as Hartalega increases its foothold in regional markets like China. Potential headwinds could include prevailing price competition, volatile fluctuations in the forex market, rising interest costs and oversupply in the rubber glove industry.

Valuation and Recommendation

Although Hartalega’s 1QFY18 results were within our estimates – accounting to 24.1% and 26.4% of our full year net profit at RM399.4 mln and revenue at RM2.28 bln respectively, we raised our earnings forecast for FY18 and FY19 to RM414.9 mln (+3.9%) and RM477.5 mln (+2.0%). The revised estimates were made on the basis of stronger potential earnings in store, which will be supported by higher revenue contribution in-tandem with increasing production capacity (+15.0%-18.0% per annum), lower volatility as the Ringgit normalises and lower tax expense.

Nevertheless, we reiterate our HOLD recommendation on Hartalega with a higher target price of RM7.30 (from RM7.05) after imputing the higher sales volumes as the group ramps up production with the additional capacity from Plant 4 in FY18.

We remain sanguine that the additional capacity churned out by the group can be sufficiently absorbed by the market, with demand for rubber gloves set to expand around 8.0% to 10.0% per year.

Our target PER of 29.0x remains at a premium to its peer’s average of 22.0x on its revised FY18 EPS of 25.2 sen (from 24.3 sen previously) due to: (i) Hartalega’s concrete position as the global market leader in the nitrile glove segment, (ii) superior operational efficiency in terms of production speed and the lower number of workers per glove output, (iii) consistent and high quality control standards, and (iv) 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 - 9 Aug 2017