Recovering But Still Short

Hartalega (HART) reported a disappointing set of results for 1HFY20, as PATAMI of RM198m (-19.2% yoy) fell short of both consensus and our expectations, delivering only 41% and 43% of FY20 forecast respectively. However, HART did manage to reverse the declining sales volume since 3QFY19 by lowering the margin (per glove) to spur demand. Overall utilisation for the quarter has also improved to 85% (from 76% in 1QFY20). Although we increase our TP to RM4.50, we are still keeping our SELL call, as we believe that stock valuation is rich.

Cut Margins to Support Volume Growth

Unlike previous quarters in which management focussed on maintaining its overall profitability by maintaining the EBITDA per glove relatively stable, we believe that HART has reduced its margin (per glove) to bolster sales volume and has since managed to reverse the declining sales volume trend since 3QFY19. Overall sales volume for 2QFY20 is up 14% qoq and 7% yoy, but EBITDA/glove is down by 3% qoq and 6% yoy. Going forward, we believe that HART is unlikely to cut its margin as significantly as in 2QFY20, as demand has started to improve, and HART is already operating at 85% utilisation rate.

Still Fall Short of Expectations

Despite cutting our EPS forecast by 3.5%-8.1% in 1QFY20E, HART’s results still fell short of our expectation, as we were expecting a stronger recovery starting 2QFY20E, supported by manufacturers restocking on Malaysian gloves. However, our recent check suggests that manufacturers’ purchase behaviour has started to normalise in the recent month, which could indicate a stronger 2HFY20 for HART and its peers. Given the recovery in demand, we believe that HART will likely maintain their expansion target, with the commissioning of Plant 6 in 4QFY20.

Maintain SELL With a Higher TP of RM4.50

We have cut our FY20-22E EPS forecast by 5.3%-5.4% to factor in lower profit per glove into our forecast. However, we have raised our 12-month TP to RM4.50 (from RM3.70), based on 30x CY20E PER (5-year average), as we roll forward from FY20E. Despite the increased TP, we are still keeping our SELL call unchanged, as we believe that current valuation is still rich. 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 rawmaterial prices.

Source: Affin Hwang Research - 6 Nov 2019