We are downgrading our call on Hartalega (HART) from Hold to SELL due to its demanding valuation, as the stock is trading above +2 stdev of its historical mean even at our revised TP of RM9.30. There is no doubt that HART will benefit from the ongoing glove shortage, but we believe that it would be challenging for it to deliver a similar >50% growth rate in FY19E, as it is already running at full capacity, and that margin expansion would not be as significant as in FY18E.

Already Running at Close to Full Capacity

Since 4QFY17, HART’s plants have been operating at utilisation rates of >90%, close to its maximum capacity and above its historical average of 85%-88%. We have revised up our utilisation rate forecast to 92%, as our channel checks suggest that demand is likely to remain robust due to the vinyl glove shortage. We forecast a strong earnings growth in FY18E of 53%, which partially takes into account stronger utilisation rates versus the average utilisation rate in FY17 of 87%.

Maintaining Profitability With Controlled Expansion

Our recent meeting with management indicated that it is still sticking to its annual capacity growth rate target of 15-20%. We believe the move is consistent with that of other rubber glove manufacturers, as they want to maintain the current supply gap. With the shortage, HART and the other manufacturers would be able to command better margins in FY18E relative to FY17. For FY19E, however, we expect a more modest margin expansion and growth rate versus FY18E, as HART would have benefited from the spike in demand starting from 2QFY18E.

Downgrading on Demanding Valuation

We are raising our FY18-20 EPS forecasts by 2.0-10.2% to factor in the better growth prospects. As we also roll forward our valuation to FY20E, we have raised our TP to RM9.30 on a slightly higher multiple of 26x, from RM7.20 (25x CY18E PER). Given the demanding valuation, at above +2 stdev its historical PER average, we are downgrading our call to SELL from HOLD. We prefer Top Glove (TOPG MK, RM7.82, BUY) for exposure to the rising glove demand, due to its cheaper valuations. The biggest risk to our investment thesis on HART would be even stronger-than-expected demand for gloves, due to the blanket ban on vinyl glove manufacturing in China.

Source: Affin Hwang Research - 28 Dec 2017