We came back from a company visit to Hartalega Holdings (HART) feeling optimistic about its prospects for the medium-to-long-term. However, it may face some minor short-term setbacks. Key takeaways from the company visit include: (i) 4Q13 results expected to come in below our and consensus expectations, (ii) new gloves capacity expansion plans for FY15 and FY16 are on track; and (iii) contrary to market expectations of an impending oversupply of rubber gloves, HARTA is recording solid demand for nitrile gloves over the last two months. We understand that the Next Generation Integrated Glove Manufacturing Complex (NGC) is on track to commission commercial production gradually from Oct 14 onwards with a planned commissioning of two lines per month. We are cutting our FY14E and FY15E earnings forecasts by 10-12% taking into account slight margin erosions. Correspondingly, our target price is reduced by 10% from RM8.21 to RM7.48 based on 20x FD CY15 revised EPS. Still, we like Hartalega for its: (i) highly automated production model, (ii) solid improvement in its production capacity and reduction in costs leading to better margins compared to its peers, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position. Reiterate our OUTPERFORM rating.

4Q14/FY14 results expected to come in below expectations. The 4Q14/FY14 results announcement is expected by 6th May (Tues). While sales volumes could have grown a commendable 10-12% QoQ which is a stark contrast to peer like Top Glove (TOPG MK; MP; TP: RM5.58) which volume declined by 7% QoQ, 4Q14 net profit will likely be weaker between 12% and 16% QoQ; bringing full-year FY14 PAT to RM230m-240m or 6-11% below our and consensus estimates. The culprits are cost pressures emanating from higher plant maintenance (shorter replacement cycle for formers from every three years to yearly as per clients’ requirement to maintain quality), electricity, consumables and labour (hiring ahead of 4QCY14 commissioning of NGC). Higher sales of latex based gloves, which currently accounts for 10% and going forward compared to 5% previously, also contributed to the lower margins. Looking ahead, with its existing plants running at optimum capacities, sales volumes will remain relatively flattish at least until 3Q15. However, management reiterated that 4Q14 margins are expected to sustain in subsequent quarters and start improving once the NGC plant 7 begins commercial production due to economies of scale.

NGC expansion plans on track. HART highlighted that its Next Generation Integrated Glove Manufacturing Complex (NGC) is on track to commission operations gradually from Oct-14 onwards with a planned commissioning of 2lines per month. Upon full commissioning, the first two plants will add c.8b pieces (+56%) new capacity by Oct-2015 and providing the much-needed earnings growth for FY16. Hartalega appears relatively confident that capacities for the first plant will be absorbed upon commissioning. We understand that a major client has been found to take up a sizeable portion of the first plant production.

Solid demand in the month of February and March 2014, lag impact in gas cost pass through. Industry-wise, Hartalega expects: (i) double-digit demand growth for nitrile gloves (15-20% for 2014-15; 10-15% for 2016-18) and (ii) to preserve market share once the new capacities come on-stream from Oct-14 onwards. Recent gas price hike translates into a small 1-1.5% ASP hike for full pass-through but with the short lead time between announced new rates (mid-Apr) and effective date (1st May), the revised ASPs will only apply to orders from June onwards, resulting in Hartalega ‘absorbing’ this incremental cost only from May.

Downgraded FY14E and FY15E net profits by 10%. We are downgrading our FY14 and FY15 earnings forecasts by 10-12% taking cue from lower margin (net margin reduced from 21% to 18%) due to higher-than-expected cost in 4Q14 as explained above. Correspondingly, our target price is reduced by 10% from RM8.21 to RM7.48 based on 20x FD CY15 revised EPS (at +2.0 SD of its historical average).

Maintain OUTPERFORM. Key risks. Delay in commissioning of production lines.

Source: Kenanga