Results Highlights

• Hartalega ‘s 3QFY18 net profit jumped 70.7% Y.o.Y to RM113.0 mln, from RM66.2 mln in the previous corresponding period, in-tandem with the 32.2% Y.o.Y growth in revenue to RM603.1 mln vs. RM456.3 mln in the 3QFY17. The stellar performance was also contributed by higher production capacity, improvements in operational efficiencies and a net forex gain. The group has also declared a second interim dividend of 4.0 sen per share, payable on 28th March 2018. Further, its dividend policy was also revised to a 60.0% payout from earnings (from 45.0% dividend payout previously), effective in FY18.

• Meanwhile, cumulative 9MFY18 net profit soared 66.7% Y.o.Y to RM322.7 mln, from RM193.6 mln a year ago, on the back of a stronger revenue of RM1.79 bln (+38.1% Y.o.Y), from RM1.30 bln in the same period a year ago and a net foreign exchange gain of RM13.8 mln (from a net forex loss of RM10.9 mln previously). The reported earnings and revenue were well within our expectations - accounting to 77.1% of our FY18 estimated net profit of RM418.1 mln and 75.0% of our FY18 revenue of RM2.39 bln.

• Todate, Hartalega has progressively commissioned ten-out of the twelve production lines in Plant 4, alongside the construction of Plant 5. Production rate is expected to remain at high levels, still above 90.0%, bolstered by robust demand for nitrile rubber gloves.

• Moving forward, we maintain our positive view on Hartalega’s growth trajectory, underpinned by increasing sales volume, high operational efficiency and higher ASPs amid the prevailing supply shortages of rubber gloves due to stringent environmental laws in China. Its bottomline will also be helped by slightly better margins as the group pass through any additional costs to its customers.

Prospects

Going forward, Hartalega is expected to accelerate its capacity expansion plans to take advantage of the upsurge in rubber gloves demand, mainly due the supply shortages of vinyl gloves in China. Consequently, the group has commissioned ten-of-the twelve production lines in Plant 4, ahead of our anticipated schedule of seven lines. Hartalega has also begun the construction of Plant 5, which we expect will be gradually commissioned by 2H2018. Running at a high average utilisation rate of above 90.0%, production volume is forecast to be between 28.0 bln – 34.0 bln pieces of gloves per annum from FY18 to FY19.

Meanwhile, we look forward to the roll-out of the group’s non-leaching antimicrobial nitrile examination gloves, which is expected to be launched in Europe in 2Q2018. The group is also currently in the process of securing Federal Drug Administration (FDA) approval for entry into the U.S. market. We think that the new product is unlikely to contribute a significant jump to margins at the current juncture, as it will be competitively priced lower in order to gain market share. However, we remain optimistic that the new development presents a potential opportunity for the group to sustain its leading edge in the increasingly saturated nitrile gloves industry.

Valuation and Recommendation

Although Hartalega’s recent results were in-line with our estimates, we raised our FY18 revenue and earnings forecast slightly to RM2.42 bln and RM423.9 mln respectively after imputing higher sales volume forecasts. We also adjusted our FY19 revenue and net profit estimates upwards to RM608.1 mln (+9.8%) and RM3.12 bln (+4.8%), on the back of adjustments made on the forex exchange assumptions (to reflect the weaker US Dollar), better production volume growth and higher ASPs as glovemakers pass through the rising costs to customers.

Separately, Hartalega has also proposed to undertake a bonus issue of up to 1.71 bln new shares on the basis of one bonus share-for-every one existing Hartalega share. The proposed bonus issue is expected to be completed in the 1Q2018, while the entitlement date will be announced later. Assuming a full exercise of all of its outstanding ESOS options, Hartalega’s share base will be hiked up by 100.0% to 3,428.6 mln shares (from 1,714.3 mln). Based on yesterday’s closing price, ex-bonus issue share price is expected to be adjusted by 50.0% to RM5.42. We view the proposed bonus issue favorably as a means to reward its shareholders.

Consequently, we upgrade our recommendation on Hartalega to a HOLD call (from Sell) with an ex-bonus target price of RM5.50 (previously RM10.40), based on an unchanged target PER of 31.0x on Hartalega’s adjusted FY19 EPS of 17.7 sen, following the sharp correction in Hartalega’s share prices recently and continuous expansion activities by the group.

Our target PER of 31.0x is at a premium to its competitors, which we think is justified in-view of: (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, however, could 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 some of its raw material costs are denominated in the U.S. Dollar, thus any fluctuations in USD/RM will impact the company’s earnings. Meanwhile, the increasing production costs (electricity, gas and labour) could also pressure margin expansion, although slightly offset by the group’s cost saving measures and higher efficiency from the integration of its NCG plants, as well as the group’s ability to pass through the additional costs to customers.

Source: Mplus Research - 7 Feb 2018