Results Highlights

• Hartalega posted a 24.7% Y.o.Y fall in its 1QFY20 net profit to RM94.1 mln, from RM124.9 mln a year earlier, owing to lower sales volume and increased operational costs (i.e.: packaging, electricity, heat and labour). Revenue also fell, but by a smaller degree to RM640.1 mln (-9.4% Y.o.Y), from RM706.4 mln last year.

• The latest earnings were and revenue were below expectations – accounting for only 16.6% and 19.2% of our previous full-year forecast net profit and turnover of RM566.3 mln and RM3.34 bln respectively. The variance is mainly due to lower-than-expected sales volume and higher utility costs, in-tandem with the recent natural gas tariff hike by Gas Malaysia.

• Consequently, we trim our FY20-FY21 net profit estimates by 29.5% and 18.9% to RM433.7 mln and RM498.7 mln respectively, mostly accounting for lower sales volumes, weaker utilisation rate and rising costs. Revenue for FY20 and FY21 was also lowered to RM2.78 bln and RM3.16 bln respectively. Although, nitrile and butadiene prices remain lower than last year, however, any cost savings will be passed on to the customers eventually, limiting margin gains, in our view.

Prospects

Going forward, the sudden increase in gas prices is likely to be priced into Hartalega’s future selling prices as the group adopt the cost-pass through mechanism, while previous concerns of a major oversupply in the market has since normalised as giant manufacturers regulate expansion activities, albeit ASPs are still limited by the influx of new capacity within the industry.

Meanwhile, its utilisation rate fell to its lowest at below 80% in 1QFY19, from 92% in the same period last year. We expect utilisation to recover in the following quarters, on the back of resilient demand for rubber gloves worldwide.

On expansion, Plant 5 has been fully operational in 1QFY19, while Plant 6 is currently under construction and is schedule to run in 2H2020, alongside the construction of Plant 7. The group is expected to have an annual capacity of 44.7 bln in FY22, from 36.6 bln currently, following the completion of the aforementioned facilities.

Meanwhile, capex requirements which will focus on capacity expansion and 4.0 technological upgrades in the next three years; expected to come up to RM745.0 mln (RM630.0 mln for plant expansion/RM115.0 mln for industrial 4.0 tech).

Valuation and Recommendation

We downgrade our recommendation on Hartalega to SELL (from Hold) with a lower target price of RM4.40 by ascribing to an unchanged target PER of 34.0x to Hartalega’s FY20 EPS of 12.9 sen as we see limited upside catalysts for the group amid tighter competition which could continue to worsen and rising costs. The group’s forward PER of 39.0x is also above its 5-year mean of 34.6x, as such, indicating that valuations are stretched currently.

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 highe refficiency 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 Aug 2019