Stock Name: HARTA
Company Name: HARTALEGA HOLDINGS BHD
Research House: MAYBANK

Rubber gloves
Upgrade to neutral from underweight: Following our downgrade on Sept 15, glove stocks fell by as much as 11% to 22% and then rebounded by 2% to 24% in the past one or two weeks. In this report, we examine the floor values, using worst case growth assumptions over 2011/13. We upgrade Kossan to a 'buy' with unchanged target price (TP) of RM3.60 but maintain ratings for Top Glove ('sell', revised TP RM4.90) and Hartalega ('hold', unchanged TP RM5.40).

To derive our rock bottom discounted cash flow (DCF) valuations, we have lowered our already conservative assumptions to a worst case scenario of slower global new demand growth and lower market share increment. Subsequently, our worst case DCF valuations could be cut by 13% to 22% to: Top Glove: RM4.72, Hartalega: RM5.03 and Kossan: RM3.17.

Both Hartalega and Kossan are already trading at our worst case scenario valuations. However, we see a potential 10% to 12% downside to Top Glove's share price. While we believe our base case fundamentals remain intact, the market could potentially look at trough valuations before glovemakers can deliver their fundamental results.

We are now buyers of Kossan because: (i) its share price has fallen 16% below our TP and is already at our worst case valuation; (ii) trading at a forward PER of seven times, Kossan is the cheapest big-cap glovemaker with comparable qualities; and (iii) its share price underperformance of 3% relative to Top Glove is unjustifiable, given that its EPS growth going forward is stronger than Top Glove's, coupled with more production in the increasingly sought-after nitrile segment. No change to our earnings forecasts and TP.

We maintain Top Glove at 'sell' because the company posted very weak 4QFY10 results last week (pretax profit: -47% year-on-year, -49% quarter-on-quarter) and is likely to see earnings contract next year. We cut our FY11/13 EPS by 8% to 9% and TP to RM4.90 from RM5.40. We continue to peg a 10% discount on our new RM5.40 DCF valuation (previously RM6) as we expect its earnings before interest, tax, depreciation and amortisation margin to revert to pre-Brazil/H1N1 levels of 15%. Based on our revised earnings forecasts, the stock now trades at relatively pricey valuation of 14 times CY11 PER (against its five-year historical average of 12 times and peers of five to 10 times) on a sector lowest three-year net profit CAGR of 4%.

Our 'hold' call on Hartalega remains, as the company appears to be more invincible than its peers with share price outperformance of 19%. Nevertheless, we would only be inclined to upgrade the stock when the oversupply situation has eased, likely in the next three months. No change to our earnings forecasts and TP. ' Maybank IB Bhd Research, Oct 11


This article appeared in The Edge Financial Daily, October 12, 2010.