Results Highlights

• Hartalega’s 4QFY19 net profit dropped 21.7% Y.o.Y to RM91.4 mln, from RM116.7 mln, despite higher revenue, dragged down by increased costs and a sharply stronger Ringgit during the quarter under review. Revenue was 10.9% Y.o.Y higher at RM683.9 mln, from RM616.8 mln a year ago and the group has declared a third interim dividend of 1.9 sen per share, payable on 27th June, 2019.

• Full year net profit came in below our expected FY19 net profit of RM496.5 mln, at only 91.9% of our full year forecast, although revenue were in-line, contributing about 98.8% of our forecast revenue of RM2.86 bln. The difference in bottomline were mainly due to weaker-than-expected EBITDA margins, which were impacted by the sudden weakness in the USD and rising operational costs (raw materials, fuel and labour).

• Despite increasing ASPs and higher sales volume in FY19, net profit growth was limited by negative forex fluctuations that hit full-year net profit with a forex loss of RM6.4 mln, compared to a forex gain of RM30.3 mln in FY18. Meanwhile, increasingly aggressive competition in the already saturated glove sector also kept capacity expansion even more paced to avoid an oversupply in the market.

• Consequently, we adjusted our FY20 net profit and revenue forecast lower to RM566.3 mln (-8.0%) and RM3.34 bln (-3.4%) after adjusting our ASPs slightly lower, in-view of increasing supply in the market as well as lower margins due to rising costs. We also introduced our FY21 forecast net profit and revenue of RM614.9 mln and RM3.70 bln respectively.

Prospects

On the expansion side, the majority of the proposed lines in Plant 5 is already up and running, while the remaining lines are expected to be commissioned in 1H2019. The construction of Plant 6 is also on-schedule, while Plant 7 is targeted for construction May 2019. Floor utilisation was slightly lower at 88.1%, compared to 90.7% last year. Subsequently, we expect utilisation rate to remain at current levels in the near-term due to increasing supply.

Meanwhile, the prolonged weakness in latex prices is also expected to continue due to high inventory levels and soft demand from China, capping Hartalega’s ability to fully pass on additional costs to consumers.

In times like this, gloves manufacturers usually rely on churning out higher volumes to improve productivity and increase margins. However, the increasing risk of oversupply means that aggressive expansion is limited in order to prevent a price war amongst the glove players.

Moving forward, we expect to see minor improvements in EBITDA margins as the group increases its ASPs, in-tandem with sudden spike in Ringgit in 4QFY19. Meanwhile, progressive capacity expansion, resilient demand and stronger USD are also expected to support turnover growth, albeit still capped by rising costs.

Valuation and Recommendation

We downgrade our recommendation on Hartalega to HOLD (from Buy) with a lower target price of RM5.15 by ascribing to an unchanged target PER of 30.0x to Hartalega’s FY20 EPS of 16.9 sen as we think that the share price is fairly valued at the current juncture, given the tightening competition amongst global glove makers and prospect of weaker margins. Potential upside catalysts include stronger Greenback and higherthan-expected demand.

Our target PER remains at a 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 the USD/RM rate 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 - 8 May 2019