Results Highlights

• The group posted a 29.6% Y.o.Y jump in its net profit to RM124.9 mln for 1QFY19, from RM96.4 mln in 1QFY18. The improvement in its bottomline was mainly due to higher sales orders and production capacity. Meanwhile, lower raw materials and operational costs also contributed to Hartalega’s earnings growth. Revenue for the quarter was 17.5% Y.o.Y higher at RM706.3 mln, compared to RM601.0 mln in the previous corresponding year.

• Both the reported earnings and revenue were broadly within our forecasts, accounting to 21.6% and 22.7% of our expected full year net profit of RM577.5 mln and RM3.11 bln respectively.

• Following the commissioning of Plant 4 previously, the group has also begun the commissioning of Plant 5 in August (slight delay from original schedule of June 2018), while the construction of Plant 6 still in-progress. Together, both plants are expected to increase its annual installed capacity by 9.4 bln pieces gloves per year. Hartalega has also successfully launched it non-leaching antimicrobial nitrile examination gloves in the U.K. in May. Currently, the group is in the midst of obtaining the U.S. Federal Drug Administration (FDA) approval, which will enable the group to export the new product to the U.S. in the future.

• The group’s earnings and revenue growth prospects remain strong, expanding at double-digit five-year CAGR of 27.5% and 27.4% to RM706.3 mln and RM3.84 bln respectively by FY20.

Prospects

Plant 5, which was initially planned for commissioning in July, was pushed to August while Plant 6 has commenced construction in June and is slated to be commissioned by 1H2019 followed by Plant 7 in 2H2019. The group has maintained high levels of utilisation rate of above 90.0% in 1QFY19, which is forecast to continue in the coming quarters.

Meanwhile, the spike in demand due to the curtailments of several Chinese vinyl glove factories previously has since normalised as some of the China plants have resumed operations after winter. Rising operational costs arising from higher minimum wages and gas is expected to weigh on margins, albeit capped by higher production volumes and ongoing operational efficiency efforts, while any remaining cost increase will eventually be passed on to consumers.

Potential tailwinds include tighter-than-expected gloves output in China, which could boost orders and prompt consolidation in the Chinese rubber glove sector, which would support ASPs. Further, Malaysian glovemakers also stand to benefit from Washington’s proposal to slap 25.0% tariffs on China-made gloves, which could potentially reduce the premium of nitrile gloves vs. its vinyl counterpart, encouraging the take-up rate of nitrile rubber gloves.

Valuation and Recommendation

As the 1QFY19 results came in broadly within our full-year estimated net profit and revenue of RM577.5 mln and RM3.11 bln respectively, we kept our forecast largely unchanged, with the exception of minor tweaks in its earnings by about 1.0% to account for lower tax rates due to re-investment allowances. Consequently, FY20 net profit estimates were also slightly higher at RM706.3 mln (+1.3%) after factoring in lower tax expenses.

We maintain our HOLD recommendation on Hartalega with a higher target price of RM6.25 (from RM6.20), based on an unchanged target PER of 35.6x to the group’s FY19 EPS of 17.5 sen. We are still positive on Hartalega’s growth prospects, underpinned by resilient demand for nitrile gloves, ongoing capacity expansion and experienced management leaders.

Our target PER remains at a premium to its competitors premised on: (i) Hartalega’s solid 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 of 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 U.S. Dollars, thus any fluctuations in USD/RM will impact the company’s earnings. Meanwhile, the increasing production costs (electricity, gas and labour) could also pressure margins 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 - 8 Aug 2018