Highlights

• We attended Hartalega analyst briefing yesterday and walked away feeling neutral.

• Recap of 4QFY03/16 result… EBIT margin fell sharply from 22% to 17% YoY (or EBIT/1k gloves fell from RM20 to RM16), mainly due to time lag effect on pricing adjustment after the increase in cost such as latex (increased from RM3.5/kg from end of 2015 to RM4.4/kg), natural gas coupled with higher initial opex cost for Plant 3 and Plant 4.

• Recovery of margin… For the subsequent quarters, we expect margin to recover on the back of i ) higher utilisation rate (expect to recover from 81% to 85-90%% level ) and ii ) increase in ASPs (circa +4% QoQ) to reflect rising production costs.

• Plant 3 and 4 are ready by 3Q16… Production capacity is estimated to increase to 22.7bn pieces (+17% YoY) by end of FY17 with sales target of 20bn pieces. Plant 3 and 4 are targeted to commission in 3Q16.

• OBM i s relatively small but growing faster… OBM segment now accounted for 6% of total revenue which has increased signi ficantly from 1% previously. There is huge potential for OBM in emerging market especially China and India.

• Lower tax rate in FY18 onwards… Under the reinvestment allowance tax incentive (up to 60% of capex in existing year claimable after 3 years of operational), NGC which commissioned by end of 2014 could see lower effective tax rate of 5-15% in FY18 onwards.

• Recovery in USD… USD/MYR has rebounded from the low of RM3.87/US$ in Apr 16 to RM4.10/US$ currently. Currently, we are conservatory factored in ringgit assumption of RM3.80/US$ in our FY17 and FY18 forecasts.

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

• Unchanged.

Rating

HOLD, TP: RM4.08

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

• Negatives – Possibility of increased competition in nitrile glove market.

Valuation

Maintain HOLD with unchanged TP of RM4.08 based on 22x of CY17 EPS.

Source: Hong Leong Investment Bank Research - 9 Jun 2016