- We maintain our HOLD recommendation on Hartalega Holdings but raise our fair value of RM6.10/share as we roll forward our valuation base to FY15F and raise our target PE to 17x (previously at 15x) to narrow the discount to industry peer and leader (in volume terms) Top Glove’s 19x. Its market capitalisation has also surpassed Top Glove’s.

- In a filing to Bursa Malaysia yesterday, Hartalega announced that it has entered into an agreement to purchase a 112-acre land (3x its current land size) in Sepang for RM97mil. Based on our checks on land prices in the vicinity, we deem the combined acquisition price of RM19.84/sq ft to be fair.

- We gather that the acquisition will be funded by a revolving credit facility. The group’s financials remain healthy with FY13 net cash of RM170mil. The estimated FY14F-FY16F capex of RM750mil for the NGC can be internally funded.

- This parcel of land had been earmarked for Hartalega’s Next Generation Integrated Glove Manufacturing Complex (NGC) since February 2012. Given the 6-month acquisition delay from an end-2012 target, this notice will admittedly allay some doubts over the group’s long-term growth plan and improve its earnings visibility.

- Recall that NGC is a RM1.9bil, 8-year investment which will see Hartalega’s installed capacity grow to 43bil pcs per annum (p.a.) by FY21 (10-year CAGR of 14%). The additional capacity will be contributed by 72 lines from 6 new plants.

- We believe this project will enable Hartalega to further reduce its cost per glove (FY13: -9% YoY to 6.9 sen) following:- (1) efficiency gains from greater economies of scale; (2) increased productivity from the automation of its inspection and packaging processes; and (3) opportunities to fine-tune its cost structure.

- More importantly, we highlight that earnings will only pick-up in FY16F, when its installed capacity reaches 20 bil pcs p.a. (+30% YoY). The group’s FY14F-FY15F net profit growth will be capped by rising costs and its lack of capacity (CY13-14 capacity growth of 2% vs. peers’ 3% average) which will hamper its ability to further exploit the current robust glove demand (FY14F: +8% to +10%).

- Hartalega’s share price has rallied 33% YTD. We attribute this to:- (1) investors re-rating the group based on their past experience with Top Glove; (2) emergence of various health threats; and (3) the sharp recovery of the USD against the RM (+6% in the last month to reverse the earlier 5% decline).

- No change to our FY14F-FY16F earnings and gross DPS forecasts. We have already incorporated the lower contribution from NGC into our earnings model. Post the sharp rise in its share price, Hartalega’s FY14F-FY16F average dividend yields of 2.8% are decent, but not attractive.

Source: AmeSecurities