We met with management for update on Hartalega. We expect a soft 4Q19 due to (i) forex impact (ii) minimum wage hike and (iii) competitive pressures on ASP translating into anaemic volumes. Consequently, we are revising our FY19- 21 earnings downward by 4.4%. Post earnings revision, our TP decreases to RM5.33 (from RM6.12), we also revise our PE to 33.7x (+0.5SD above 3 year mean). We are upgrading to a BUY on valuations (trading below its 3 year mean) as we believe the share price weakness has now offered sufficient buffer.

We met with management to get an update on Hartalega. The following are some of the key takeaways.

Recap. 9MFY19 revenue of RM2144.0m (+19.9% YoY) translated into core PATAMI of RM367.1m (+13.7% YoY). Volume improved on the progressive commissioning of Plant 5 (+3.0% QoQ, +11.6% YoY), whilst ASP softened during the quarter (-2.0% QoQ, +6.4% YoY) due to the decline in Nitrile prices and competitive pressures.

Capacity expansion. The commissioning of the first lines of Plant 6 (4.7bn pieces p.a.) which was earlier guided for 1HCY19 has now been pushed forward to 2HCY19. We view this in a positive light and in line with other industry players (i.e. Top Glove), which should aid in the alleviation of ASP pressure. Factory 5 which has 2 lines to go is being commissioned at a rate of 1 line per month from 2 lines a month.

NGC-2. NGC-1 will culminate in Plant 7 (2.6bn pieces p.a. - specialty gloves) which has been guided to commence construction in mid-2019 with targeted commissioning of the first line by Jan 2020. We understand that concurrently, management are on the prowl for a parcel of land for NGC -2 (minimum size requirement is c.80 acres). We do expect an announcement sooner than later on this, given it is a crucial determinant for the group to sustains its multiyear earnings growth momentum.

4Q19. We expect a soft 4Q19, as margins face downward pressure on the back of (i) forex impact (USDMYR -2% QoQ) and (ii) the increase in the mandatory minimum wages in January (+10% YoY), against a backdrop of competitive pressures on ASP translating into anaemic volumes.

AMG. We understand that Hartalega’s antimicrobial glove is still awaiting FDA approval. The approval process is lengthened given that the FDA views the AMG as a new product category. We expect contributions from AMG to be miniscule in FY20 before pace picks up post FDA approval expected in the latter part of FY20.

Forecast. We are adjusting our FY19-21 earnings downwards by 4.4% as we account for expected lower volumes on market share losses due to competitive industry pressures within the Nitrile glove space.

Upgrade to BUY, TP: RM5.33. Post earnings revision, our TP decreases to RM5.33 (from RM6.12). We take this opportunity to lower our PE target to 33.7x (+0.5SD above 3 year mean) from 37x (+1SD) to account for the challenges within the Nitrile segment. Despite the earnings and TP cut, we are upgrading Hartalega to a BUY due to (i) the anticipation of a weak 4QFY19 is has been largely priced in (-24% YTD), (ii) valuations have come off significantly in recent times, with the stock trading below its 3-year mean, having not traded at these levels since Oct 2017 (refer to Figure# 1) and (iii) sequentially weaker ringgit sentiment which should put export plays in flavour.

Source: Hong Leong Investment Bank Research - 18 Apr 2019