We are more optimistic about Hartalega’s growth prospects and outlook in subsequent quarterly earnings. Our conviction is reinforced by the completion of Plant 3, which drove double-digit volumes in 4Q17. We expect higher FY18 and FY19 net profits on the back of completion of Plant 3 and higher utilisation underpinned by stronger-thanexpected demand. We believe the stronger growth prospect will lend support to Hartalega’s high teens PER rating as the stock is head and shoulders ahead of peers in terms of margins, efficiency and profitability. Reiterate OUTPERFORM with a higher TP of RM7.70 based on 29.5x CY18E revised EPS.

Consensus under appreciating Hartalega’s earnings. Taking the cue from Hartalega’s 4Q17 results, we expect FY18 and FY19 net profits to register higher than our estimates. Due to the solid volume growth in 4Q17 and Hartalega’s persistent effort in expanding into other countries, we expect utilisation rate for Plant 3 at 88%, which is in line with its historical average. Recall, Hartalega’s 4Q17 PATAMI came in at RM89m (+35% QoQ) underpinned by higher sales volume (+14%) as a result of full utilisation in Plant 1 and 2 as well as gradual commercialisation of Plant 3 and margins improvement due to the reduction of operation overhead and improvement in operational efficiency. 4Q17 EBITDA margin improved 5.2pts to 26.2% from 21.0% in 3Q17.

Solid industry demand and longer delivery lead times to underpin growth going forward. Solid industry numbers and longer delivery lead times are indicating that demand will outstrip supply at least over the medium term. Case in point is 1Q17 when the total exports of rubber gloves, synthetic rubber (SR) and latex-based natural rubber (NR) combined rose an estimated 10% YoY. Furthermore, Hartalega has managed to penetrate into new markets of which they are currently in >50 countries compared to >30 in the past which further reinforced solid demand. We understand that the robust demand for nitrile has led to longer delivery lead times.

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 gradual ramp up in Plant 3 to boost earnings in subsequent quarters. We expect volume sales to surge following the lower average input latex cost in tandem with falling raw material latex price. 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. In anticipation of higher demand, we expect Hartalega to start building Plant 4 with an estimated capacity of 4bn pieces per annum expected to be ready in early 2018.

We raised our FY18E/FY19E net profit by 18%/14%. We raised our FY18E and FY19E net profits by 18% and 15%, respectively, to take into account higher volume sales (+20% growth rate compared to 16% previously) and utilisation rate of 88% compared to 82% previously underpinned by Plant 3.

Maintain OUTPERFORM. Correspondingly, we upgrade our target price from RM6.00 to RM7.80 based on 29.5x CYE18 revised EPS (+1.0 SD above 4-year forward mean). Apart from higher earnings, we raised our target PER from 26.5x to 29.5x. The stock has been trading at PER of between 22.0x to 35.0x over the past four years. We believe the valuation is justifiable considering that Hartalega is head and shoulders above its peers in terms of profitability and margins. All in, we like Hartalega for: (i) its superior margins, solid improvement in production capacity and reduction in costs, (ii) new capacity expansion to boost earnings, as well as (iii) the dominant market positioning in the booming nitrile segment.

Source: Kenanga Research - 30 Jun 2017