Highlights/ Comment

From our recent company visit, we gathered that Hartalega’s FY14’s bottom line is rather flat yoy. In turn, we are expecting 4QFY14 core net profit to be weaker qoq compared to 3QFY14’s RM55m.

The recent natural gas tariff hike will increase its cost by ~19%. Based on the company’s natural gas cost of 7% to total expenses, this will increase their production cost by 1.3% (19% of 7%).

We understand that ASP is under pressure, which is most likely due to price competition and imbalance demandsupply situation in the rubber gloves market. It is worth noticing that ASPs have been on a downward trend since FY12.

With all the persistent headwinds, we believe that it remains challenge for Hartalega to pass on cost increases to customers.

Being the largest exporter of nitrile glove (MREPC 2013 Report), the strengthening of MYR against USD to RM3.25 adds on to the unfavourable headwinds.

The neutralisation factor is the recent softening in latex costs despite wintering season, which is currently trading at RM4.63/kg vs. RM5.22/kg 3-6 months ago.

The issue of water rationing for the whole nation is not as perturbing in Hartalega. This is chiefly due to company’s strategic planning by locating their plant near to water resources. All this while, they have been sourcing water from river nearby and treating it at their own plant.

The NGC (Next Generation Integrated Glove Manufacturing Complex) project in Sepang is expected to commence operation by October 2014.

Risks

• Further reduction in ASP amid steep competition.
• Surge in nitrile and latex prices.
• Shift in demand from nitrile gloves to natural latex gloves, if prices of natural latex fall significantly below that of nitrile.
• Depreciation of USD vs. MYR.

Forecasts

Updated model given pressure on ASP and rising costs. As a result, FY14 and FY15’s EPS were trimmed by 8.6% and 16.2% respectively.

Rating

HOLD, TP: RM6.46

Positives – Leader in nitrile glove market; highest ROE and net profit margins; most efficient and profitable glove maker. In the event of a price war, Hartalega’s earnings will be the least affected, shielded by its high profit margins.

Negatives – Possibility of increased competition in nitrile glove market.

Valuation

Reiterate HOLD with a slightly higher fair value of RM6.46 (+1.4% from RM6.37) despite lowered forecasts due to rolling forward our valuation to CY15.

Our valuation is pegged to a multiple of 16.2x based on 1SD above 5-year historical average P/E (see Figure 3) compared to previous’ 17.5x

Source: Hong Leong Investment Bank Research - 22 Apr 2014