Hartalega (HART) reported a relatively weak set of results for 1QFY20, as PATAMI of RM94.1m (+3.0% qoq; -24.7% yoy) fell short of both our and consensus expectations, delivering only 19% and 18% of FY20 forecasts respectively. We believe that the weak performance is due to the 8.5% decline in its sales volume, as margins remained relatively stable. The decline has also resulted in its overall utilisation declining to 76% in 1QFY20 (from 84% in 4QFY19). We are maintaining our SELL call but lower our TP to RM3.70.

Sacrificing Volume for Margins?

We believe that the decline in sales volume (-8.5% yoy; -7.9% qoq) was due to management’s decision to maintain its overall profitability. Based on our estimates, HART’s ASP (in US$) remained relatively stable during the quarter despite the continued decline in raw material prices. There was also some additional cost savings (lower maintenance cost) during the quarter, derived from the decommissioning of some of its older and less efficient lines in Bestari Jaya, in our view. Post the decommissioning, the average production of gloves improved from 84m pcs/annum in 4QFY19 to 87m pcs/annum in 1QFY20.

Better Quarters Ahead?

We believe that our previous forecast is not achievable, hence we cut our sales volume growth assumption from 12% to 5% for FY20E, despite management guiding for stronger quarters ahead. However, margin is likely to be sustainable due to the weakening RM and lower raw material prices, in our view. While Malaysian glove markers like HART could benefit from the 10% tariff hike on China exports to the US, there is the likelihood that Malaysian manufacturers might lose some market share before the hike, as the US distributors could potentially take more deliveries from China (cheaper products) in anticipation of the cost increases.

Maintain SELL With a Lower TP of RM3.70

We lower our 12-month TP to RM3.70 (from RM4.10), based on an unchanged 27x FY20E PER, but maintain our SELL call. The change is on the back of the 3.5-8.1% earnings cuts for FY20-22E, after factoring in lower volume forecasts. The key risk to our call would be stronger than expected growth in demand. Other risks include a sudden sharp movement of the US$ against the RM or a sharp drop in raw-material prices.

Source: Affin Hwang Research - 7 Aug 2019