1H17 PATAMI of RM127.4m (+3.5% YoY) came in within expectations at 46% of our and consensus’ full-year net profit forecasts. A first interim DPS of 2.0 sen was declared. 1H17 performance was boosted by the solid 2Q17 results, due to margins expansion emanating from operating efficiency and better economies of scale leading to volume sales. Maintain OUTPERFORM and TP of RM5.33 based on 26.5x CY17 EPS.

Result highlights. QoQ, 2Q17 revenue came in 9% higher due to higher sales volume in the nitrile glove segment (9%) which accounted for 93% of sales but was mitigated by marginally lower ASPs (-1.8%). Higher utilisation rate of 88% compared to 81% in 2Q17 boosted productivity and volume sales, which resulted in better economies of scale. As a result, pre-tax margin rose 2.2%ppts to 19.2% from 17% in 1Q17. This brings 2Q17 PATAMI to RM71.2m (+27% QoQ), boosted by a lower effective tax rate of 15% compared to 17.2% in 1Q17.

YoY, 1H17 revenue rose an impressive RM838m (20% YoY) due to higher sales volume (+27%) which more than offset lower ASPs (-7%) underpinned by new capacity from NGC and weakening of the USD against MYR. However, overall PBT margin was reduced from 24.8% to 19.4% due to increase in process chemical cost, natural gas cost, indirect labour and upkeep of plant and machinery while competitive pressure led to lower ASPs. This brings PBT to RM152m (-2% YoY). However, PATAMI rose 3.5% to RM127.4m due to lower effective tax rate of 16% compared to 1H16 of 17.6%.

Outlook. We expect Hartalega’s margin to continue to improve from 2Q17 on margins expansion emanating from operating efficiency and better economies of scale leading to volume sales. Furthermore, we gather that nitrile glove competition has subsided on the back of slower new incoming capacities, which could ease downwards pressure on ASPs. In fact we expect glove players including Hartalega to raise ASPs in subsequent quarters. Due to the lag effect in passing cost through as a result of higher natural gas and raw material (latex) costs, we expect glove makers to raise ASPs, which should contain high operating costs and put brakes on further margin compression in subsequent quarters. Looking ahead, we expect earnings to jump upon the gradual ramp-up of the Next Generation Integrated Glove Manufacturing Complex (NGC). Presently, NGC has commissioned all 24 lines of plant 1 and 2 combined. These two plants will add c.8b pieces (+56%) new capacity and provide the much-needed boost to FY17 and FY18 earnings.

Maintain OUTPERFORM. We maintain our earnings forecasts. We roll over our valuation from CY17E to CY18E. Correspondingly our target price is raised from RM4.90 to RM5.33 based on an unchanged 26.5x CY18 EPS. We like Hartalega for its: (i) highly automated production processes model, (ii) new capacity expansion to boost earnings, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position.

Risks to our call. Lower-than-expected ASPs and delay in commissioning of new production lines.

Source: Kenanga Research - 9 Nov 2016