Results Highlights

• Hartalega reported a 6.1% Y.o.Y growth in its 2QFY19 net profit to RM120.2 mln, from RM113.3 mln in the previous corresponding quarter, driven by stronger topline contribution due to higher sales volume (+10.6% Y.o.Y) and ASPs. Revenue was 22.2% Y.o.Y higher to RM714.2 mln, from RM584.6 mln last year. Following the positive results, the group declared a first interim dividend of 2.2 per share, payable on 28th December 2018.

• The cumulative 1HFY19 net profit rose 16.9% Y.o.Y to RM245.1 mln, from RM209.7 mln in 1HFY18, in-tandem with stronger revenue contribution, which grew 19.8% Y.o.Y to RM1.42 bln, compared to RM1.19 bln previously. The improvement seen was also due to growing demand for nitrile gloves, rising production capacity and higher ASPs, albeit slightly capped by unfavorable net forex losses.

• The reported net profit and revenue was below our expectations, accounting to 42.1% of our previous full-year forecast net profit of RM582.7 mln, while revenue accounted for 45.6% of our estimated RM3.11 bln. The difference was largely due to lower-thanexpected production capacity and sales volume, albeit slightly offset by stronger ASPs.

• We upgrade our recommendation on Hartalega to a HOLD (from Sell) with a higher target price of RM6.55 (from RM6.25), after rolling forward our valuations to FY20 to better reflect its long-term growth prospects, which will be underpinned by consistently high levels of utilisation, ongoing capacity expansion and product differentiation (i.e: Anti-Microbial Glove), which could potentially help Hartalega achieve even more lucrative margins in the long run. We arrive at our target price by ascribing to a lower target PER of 34.0x to Hartalega’s FY20 EPS of 19.4 sen.

Prospects

The commissioning rate of its new production lines were slower-than-expected with only three lines up and running in Plant 5, vs. our forecast of six lines. Moving forward, Hartalega targets to commission about two new lines every month, while the construction in Plant 6 is on schedule and slated for commissioning in 2H2019. Plant 7 is also expected to begin production towards late 2H2019. Average utilisation rates remain at high levels, although it slipped slightly to 90%, from 92% in the same period last year.

The group has made its first shipment of Anti-Microbial Gloves (AMG) to a major German medical supplies company in September and has also received orders for the AMG in over ten countries. Meanwhile, the group is still in the process of securing an FDA approval to enter the U.S. market for its AMG products. Tentatively, Hartalega aims to secure the approval by 2H2019. We are positive on Hartalega’s efforts to differentiate from the regular glove players and strengthen its foothold as a market leader in the industry, amid increasing saturation in the nitrile glove industry.

Demand is likely to remain resilient, driven by rising health and tighter regulations. Downside risks, meanwhile, include potential oversupply in the market as most glove makers are still in an expansion mode, albeit we believe that the expansion will be paced to reduce the risks of oversupply.

Valuation and Recommendation

As the reported earnings were below our estimates, we trim our FY19-FY20 net profit by 10.8%-8.7% to RM520.0 mln and RM644.9 mln respectively, after lowering our sales volume projection on slower expansion and thinner margins, in-view of rising raw materials and fuel prices. Revenue was also adjusted to RM2.93 bln (-5.8%) and RM3.51 bln (-8.6%) for FY19 and FY20 respectively.

Nevertheless, we upgrade our recommendation on Hartalega to HOLD (from Sell) with a higher target price of RM6.55 (from RM6.25), after rolling forward our valuations to FY20 to better reflect the long-term growth prospects of Hartalega, which will be underpinned by consistently high levels of utilisation, ongoing capacity expansion and product differentiation, which could potentially help Hartalega achieve even more lucrative margins in the long run. We arrive at our target price by ascribing to a lower target PER of 34.0x to Hartalega’s FY20 EPS of 19.4 sen.

Our target PER remains at a 45% premium to Hartalega’s 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 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 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 - 9 Nov 2018