- We maintain BUY on Hartalega Holdings and raise our fair value to RM9.40/share to reflect our higher fully-diluted FY16F PE target of 27x (2.5 SD above its 5-year mean).

- We recently visited Hartalega’s Next Generation Integrated Glove Manufacturing Complex (NGC) in Sepang and came away reassured of its future prospects as construction works appear to be progressing well.

- To recap, the NGC is a RM2bil 8-year investment which will raise Hartalega’s installed capacity to 42bil pcs p.a. by FY20 (8-year CAGR of +15%). The additional capacity will be contributed by 72 lines from six new plants and will provide the group with a fresh growth impetus.

- While there were a lot of building activities in progress, priority has been given to the construction of new production lines. Construction of Plants 1 and 2 (total of 24 lines) as well as the supporting facilities has been completed. As of our visit date, 5 lines are in commercial production (3 at Plant 1 and 2 at Plant 2) while the sixth was in the midst of being commissioned.

- Encouraged by the strong global glove demand (+15% for nitrile gloves), Hartalega will be simultaneously building Plants 3 and 4 in April 2015 (Phase 2 of the NGC project). The first of these new 24 lines is scheduled to begin operations in early 2016 just as the first two plants are completely commissioned.

- Hartalega’s highly automated lines are projected to run at average speeds of 45k pcs/hr, producing 4.7bil pcs per plant p.a. However, during our visit, we noticed that the lines were running at average speeds of 45.5k pcs/hr. Nonetheless, reject rates have remained low, reflecting Hartalega’s technological prowess and high OEE of 83%.

- We also noted management’s ongoing efforts to reduce its cost per glove and protect its margins (NGC’s margins are 1% above Bestari Jaya’s). The various infrastructures (e.g. production plants, raw material storage, and affluent treatment areas) were built to ensure cost efficiency. Operating costs are expected to be reduced by 12% upon NGC’s completion.

- We are leaving our FY15F-FY17F earnings forecasts unchanged. Hartalega is expected to end its FY15F on a lower note (-13% YoY) due to the lack of new capacity, price competition, and high NGC start-up costs. That said, earnings are expected to pick-up from FY16F (+33% YoY) onwards.

- Since our upgrade to BUY in December 2014, the stock has rallied by 26%, spurred partly by the sharp appreciation of the USD vs. the RM (+5%). We believe that the imminent US rate hike will continue to exert further downward pressure on the RM.

- As such, we expect valuations of the rubber glove players like Hartalega to remain inflated as investors seek a safe haven from the weakening RM and other GST-affected industries. The stock is currently trading at a fully-diluted FY16F PE of 24x.

Source: AmeSecurities Research - 3 Apr 2015