- We downgrade Hartalega Holdings from BUY to HOLD with a revised fair value of RM5.50/share as we believe that valuations are already rich at the current price and fairly reflect its strong earnings growth momentum. Our fair value is based on an unchanged PE target of 27x over rolled forward FY17F EPS.

- Since our upgrade to BUY back in December 2014, the stock has appreciated 49%, vs. the FBM KLCI’s -4% and peer average of +77%. Correspondingly, Hartalega’s PE has expanded to 30x. This is 2.5SD above its 5-year trend average of 16x.

- We believe that further upside from its favourable USD exposure, which we opine to have spurred the rally in its share price, may be limited moving forward as the exchange rate stabilizes and its price gap narrows (i.e. passing on of savings to customers).

- Hartalega yesterday reported a core net profit of RM55mil (QoQ: +18%; YoY: +38%) for 2QFY16 to bring its 1HFY16 core earnings to RM117mil. The results were slightly below our and consensus estimates, making up 42% to 43% of the respective full-year forecasts.

- The group’s 14% YoY earnings increase came on the back of a 26% rise in revenue. The topline growth can be mainly attributed to a 25% increase in sales volumes as new capacity from its NGC plants came on stream and to a smaller extent, a higher ASP, especially for its latex gloves (+15% YoY vs nitrile’s +2%).

- Hartalega’s 1HFY16 EBITDA margin, while still superior to its peers, was flattish at 29% (+0.6ppts) as it had registered a fair value loss on derivatives of ~RM27mil (vs. 1HFY15’s RM7mil loss) for the period, an increase in chemical costs and changes to its production lines.

- In view of this and a downward revision to our production capacity projections, we have tweaked our FY16F-FY18F earnings by -2% to -5%. We recently learnt that the commissioning of its NGC lines has been delayed due to former supply issues and also the postponement of the commissioning of its new NGC lines at Plant 3 and 4 from March to June 2016.

- The above will, however, be partially offset by the availability of tax incentives, namely the Special Reinvestment Allowance (RA) Incentive, which the group will be able to take advantage of in FY16F due to its capex for Batang Berjuntai plants and the standard 15-year RA for its NGC plants from FY17F.

- A first interim dividend of 2 sen/share was also declared, placing it on track to meet our full-year forecast of 9 sen/share. Forward yields are ~2% currently.

Source: AmeSecurities Research - 6 Nov 2015