Hartalega (HART) reported a weaker than expected performance for 9MFY19, as PATAMI of RM364.9m (+17%yoy) tracked behind expectations, delivering only 70% and 72% of our and consensus forecast respectively. PBT for the quarter is up by 5.4% qoq but PAT is down by -0.4% qoq, indicating that the weaker performance was largely due to the higher effective tax rate. We have lowered our TP to RM5.90 after revising downwards our EPS forecast for FY19-21E by 4.2%-7.0%. Maintain HOLD.

EBITDA/Glove Remains Stable

The EBITDA/glove (‘000) ratio gradually improved to RM24.81 in 3QFY19 from RM24.23 in 2QFY19, despite a decline in ASPs. The decline in ASP (in RM terms) was mainly due to lower raw material prices, as Hartalega returned the cost savings to its customers. We believe that the stability in the EBITDA/glove ratio during the quarter would help to alleviate some investors concern on the overcapacity issues surrounding the sector. Although we are expecting a rise in production cost (minimum wage and electricity tariff) for the next quarter, we believe that the glove manufacturers will still be able to pass on the higher cost.

Being Rationale Is Good for the Company and Sector

Although HART is currently operating at >88% utilisation rate, we view its decision to slow their capacity expansion target from an average of 2 lines a month to 1 line a month for Plant 5 positively. In our view, it would be better to match capacity growth to sales growth, rather than taking a build and they will come approach. We believe that the other glove manufacturers would act rationally as well, minimizing the risk of a potential overcapacity situation. Despite pushing backwards the completion date for Plant 5, the impact to our previous earnings forecast is limited to 1-2% for FY19-21E.

Lowering TP to RM5.90, Maintaining HOLD Call

We are lowering our 12-month TP for Hartalega to RM5.90 (from RM6.30), based on an unchanged 35x FY20E PER (+2SD), but keeping our HOLD call. The changes are on the back of a 4.2% - 7.0% cut in our EPS forecast for FY19-20E, after factoring in the developments during the quarter.

Source: Affin Hwang Research - 13 Feb 2019