Period

2Q16 /1H16

Actual vs. Expectations

1H16 PATAMI of RM123.1m (+17% YoY) came in at 42% and 45% of our and consensus’ full-year forecasts, respectively. We deemed the results as within expectation as we expect a stronger 2H16 in the absence of low to minimal forex losses in subsequent quarters. In anticipation of a sustained strengthening of the USD/MYR exchange rate, we understand that Hartalega has reverted back to two-month hedging policy from six-month duration previously.

Dividends

A first single-tier interim dividend of 2.0 sen was declared. Key Result

Highlights

QoQ, 2Q16 revenue came in 18% higher due to: (i) stronger sales volume in the nitrile glove segment (+15%) which accounted for 95% of sales, which more than offset lower ASPs (-8%). Overall, higher volume sales were underpinned by commercial operations of NGC in early Jan 2015. Pre-tax profit margin in 2Q16 fell to 19.8% from 24.9% in 1Q16 largely due to fair value loss of RM21.6m on derivatives. However, we understand that these losses will be minimal in subsequent quarters as Hartalega has reverted back to two months hedging policy from six months previously. Consequently, 2Q16 core net profit fell 3.6% to RM60.4m. Excluding the fair value derivative loss, 2Q16 core net profit would have +31% Q/Q with EBITDA margins at 30% (vs. 2Q16’s reported 24% and historical peak of 34%).

YoY, 1H16 revenue rose 26% due to higher sales volume (+30%) which more than offset lower ASPs (- 15%) underpinned by new capacity from NGC. Correspondingly, core net profit rose 17% due to lower effective tax rate of 20% compared to 25% in 1H15. PBT margin was reduced from 24.9% to 20.4% due to recognition of fair value loss on derivatives.

Outlook

Looking ahead, we expect earnings to jump upon the gradual ramp up of the Next Generation Integrated Glove Manufacturing Complex (NGC) (known as Plant 7). We were given to understand that the full commissioning of the first two plants is expected to be delayed by two months. In an effort to mitigate further costs increases, Hartalega has further strengthened its production process to be more efficient. Hence, the delay is due to retrofitting the new plant to incorporate new energy saving device design – a flanking manoeuvre to anticipate and mitigate future energy hikes, causing a slight delay in fully commissioning Plant 1 and 2. Presently, NGC has commissioned 17 lines. Upon full commissioning, the first two plants will add c.8b pieces (+56%) new capacity by 1Q16 and providing the much-needed earnings growth boost in 2H16 and FY17.

Change to Forecasts

No change to our earnings forecasts.

Rating

We like Hartalega for its: (i) highly automated production processes model, (ii) solid improvement in 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. Maintain Outperform and TP of RM6.00 based on unchanged 27x CY17 EPS (slightly above +1.0 SD above its 5-year historical mean average).

Risks to Our Call

Lower-than-expected ASPs.

Source: Kenanga Research - 6 Nov 2015