Hartalega (HART) reported 1QFY18 PATAMI of RM124.9m (+7.1% qoq; +29.6%qoq), tracking within our and consensus expectations, delivering 24% and 25% our respective forecast. The qoq improvement is due to stronger sales volume and also a recovery in margin, as the strong demand for rubber glove has allowed Hartalega to raise its ASP to cover rising costs. Earnings growth is expected to continue as the new Plant 5 was commissioned in August. Reiterate HOLD with an unchanged TP at RM 6.30.

Margin Improvement Indicates Demand Remains Robust

We believe that the improvement in the EBITDA/glove (‘000) to RM 24.13 in 1QFY19 from RM 23.61 in 4Q18 has helped to allay some concerns on overcapacity and rising production cost, as Hart was still able to raise ASP and continuing to pass on higher cost. We expect Hart to continue to raise its ASP in 2Q18, as raw material prices continue to be on the rise, although the price hike could be less steep due to the recent weakening of RM. Glove manufacturers (incl Hart) will be able to pass on the higher cost with the current robust demand, in our view.

2H Earnings Growth Derived From Plant Expansion

As Hart continues to operate at >90% utilisation rate, we believe that the new Plant 5 which was recently commissioned, will be earnings-accretive. The new lines can also help to reduce the current high utilisation rate of its current lines, as operating at above 90% for an extended period of time could lead to longer downtime for maintenance. The new capacity from Plant 5 will add around 4.7bn capacity or 14% of its current capacity by year-end. Plant 6 & 7 will likely be commissioned in 1H19 and 2H19 respectively.

Maintain HOLD With An Unchanged TP of RM6.30

We are maintaining our 12-month TP for Hartalega at RM6.30, based on an unchanged 35x PER on FY20E PER (+2SD). We keep our HOLD rating as we believe the stock is fairly valued, trading at around +2SD its historical average PER. Supermax (SUCB MK, RM 4.33, BUY) and Kossan (KRI MK, RM 4.45, BUY) remain our preferred sector picks. The key risk to our call would be management’s inability to ramp up the utilisation rate of the new capacity. A sudden sharp movement of the US$ against the RM or a sharp change in raw-material prices would also impact profitability.

Source: Affin Hwang Research - 8 Aug 2018