9M17 PATAMI of RM194m (-1% YoY) came in within expectations at 70% of our and consensus full-year forecasts. 3Q17 marked the second consecutive quarterly hike in ASPs. A second interim DPS of 2.0 sen was declared bringing 9M17 DPS to 4.0 sen which is within our expectation. We expect better sequential 4Q17 performance due to higher ASPs and new capacity expansion from plant 3 and margins expansion emanating from operating efficiency and better economies of scale due to increased capacity and higher volume sales. Maintain OUTPERFORM and TP of RM5.33 based on 26.5x CY18 EPS.

Result highlights. QoQ, 3Q17 revenue rose 4.4% largely due to higher ASPs (+4%) and flattish volume (+1%) due to full utilisation in plant 1 and 2. 3Q17 gross profit margins improved from to 23.6% from 20.1% in 2Q17 due to the reduction of operation overhead; improvement in operation efficiency and strengthening of USD. However, 3Q17 pre-tax margin fell 2.0 ppts to 17.2% from 19.2% in 2Q17 due to the recognition of fair value loss of USD denominated loans. Normalised pre-tax margin (assuming adding back the fair value loss in USD denominated loans) is estimated at 19%. This brings 3Q17 PATAMI to RM66.2m (-7% QoQ).

YoY, 9M17 revenue rose to an impressive RM1,295m (18% YoY) due to higher sales volume (+24%) which more than offset lower ASPs (- 5%) underpinned by new capacity from NGC and strengthening of the USD against MYR. However, overall PBT margin was reduced from 22.4% in 9M16 to 17.8% in 9M17 due to higher natural gas cost and competitive pressure, which led to lower ASPs. This brings PATAMI to RM194m (-1% YoY).

Outlook. Looking ahead, due to the pent-up demand for rubber gloves, NGCs plant 1 and 2 are presently fully utilised. Correspondingly, we expect new capacity from the commissioning of six lines in plant 3 to boost 4Q17 earnings and higher ASPs in subsequent quarters. We would not be overly surprised if plant 3 is fully commissioned faster than expected on the back of a strong demand. Presently, there are six lines (c.2b pieces or 9% of total capacity) operating in plant six. 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. 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. Plant 3 will add c.4b pieces (+18%) new capacity and provide the much-needed boost to FY18 earnings.

Maintain OUTPERFORM. We maintain our earnings forecasts and TP of 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 - 15 Feb 2017