Result

• Hartalega reported a net profit of RM94.1mil for its 1QFY20 results. The quarterly net profit increased 3.0% qoq but decreased 24.7% yoy. Meanwhile, quarterly revenue stood at RM640.1m, decreased -6.4% qoq and -9.4% yoy.

• Broadly within our expectation but below consensus. Overall, 1QFY20 net profit accounts for 20.9%/18.1% of ours/market full-year estimates.

Comments

• Better qoq earnings. As expected, lower revenue was registered mainly due to decrease in sales volume (ie. -9.2% qoq). However, lower operating expenses was also recorded thanks to lower upkeep, electricity and packaging cost, which resulted in a higher EBIT/EBIT margin of 3.0%/3.4%ppts.

• Weaker yoy performance. Again, revenue deteriorated - 9.4% yoy, no thanks to lower sales volume (ie. -9.2% yoy) coupled with lower average selling price (ASP) (ie. -1.02% yoy). Likewise, EBIT/EBIT margin was down -19.5%/-2.4% ppts, bogged down by higher packaging, electricity, heat and labour cost.

• Minimum impact from natural gas tariff hike. To recap, on 12 July 2019, Gas Malaysia announced to raise its average natural gas tariff by 5.3% in 2HCY19. Natural gas accounts for an average of 11% production cost. The hike in natural gas tariff is expected to impact Hartalega’s earnings by 1% to 1.5%. However, we expect the negative impact will be minimal as the Group is able to pass on the cost to customers.

• Continued expansion to capture market share. Plant 5 has been fully commissioned its production lines. Construction of Plant 6’s structure is currently underway and the supporting facilities to be followed in 2HCY19. Plant 6 will have an annual capacity of 4.7 billion pieces of gloves thereafter. Also, Plant 7 will be set up with an annual capacity of 3.4b pieces to tailor small orders and specialty products. As such, annual installed capacity is expected to increase from current 36.6b to 44.7b pieces by FY2022.

• Lack of momentum from antimicrobial gloves (AMG). The Group has received order from over 20 countries since the launch of AMG in the UK. Besides, the Group is working on securing Federal Drug Administration (FDA) approval from the US. Having said that, we do not expect the product will contribute any significant revenue to the Group in the short to-middle term.
• Gearing up for Industry 4.0 technologies. Looking forward, Hartalega will develop automation solution, IOT technology & AI solutions in order to mitigate margin pressure from higher cost of labour (ie. reduce dependency on manual work force by 18% in 3 years) and energy (ie. fuel and natural gas). However, we foresee that it will only contribute positively to the Group’s earnings in mid-to-long term.
• Unattractive Outlook. We believe Hartalega is facing supply overhang with no relief in sight resulting in lower sales volume. However, we expect slightly better earnings to be reported in 2QFY20, supported by higher average selling price (ASP), mainly due to strengthening of USD against MYR in 2QFY20.

Earnings Outlook/Revision

• We maintain our earnings forecast of RM449.6m (- 1.4% yoy) for FY20F and RM461.4 (+2.6% yoy) for FY21F.

Valuation & Recommendation

• Maintain SELL with a higher target price of RM4.48 (previous target price of RM3.97) following higher P/E applied. Our revised target price is now pegged at FY20F P/E of 34.5x (from 30.5x previously). Our valuation is at +0.5 above its 3-year mean P/E of 30.8x to reflect the Group’s strong fundamental.

• Nevertheless, we opine that the current share price is overvalued at this moment. Major upside risks include: 1) Continued strengthening USD against MYR resulting in higher ASP which offsets impact of lower sales volume, 2) Obtaining FDA approval for its antimicrobial gloves (AMG), and 3) Ability to pass on higher production costs to customers.

Source: JF Apex Securities Research - 7 Aug 2019