1Q18 PATAMI of RM96.4m (+72% YoY; +8% QoQ) came in within expectations at 24%/25% of our/consensus full-year forecasts. We expect better performance in subsequent quarters on the back of higher demand underpinned by new capacity expansion from Plant 3 and margins expansion emanating from better operating efficiency and economies of scale due to increased capacity and higher volume sales. Our TP is RM7.70 based on 29.5x CYE18 EPS. Reiterate OUTPERFORM.

Result highlights.

QoQ, 1Q18 revenue rose 14% due to higher ASP (+3.4%) and sales volume (+10.3%) as a result of full utilisation in Plant 1 and 2 as well as gradual commercialisation of Plant 3. 1Q18 PBT margin fell 3.2ppts to 19.3% from 22.5% in 4Q17 due to higher upkeep cost, depreciation expense, packaging material cost, chemical cost and term loan interest expense. The lower margin was further exacerbated by expensing out capex and maintenance capex in Plant 3, which was previously capitalised following its completion and full commercial operation. This brings 1Q18 PBT to RM115.7m (-2.3%). However, 1Q18 PATAMI came in at RM96.4m (+8% QoQ) due to a lower effective tax rate of 16.7% compared to 24.5% in 4Q17. No dividend was proposed in this quarter as expected.

YoY, 1Q18 revenue rose by an impressive 50% due to higher sales volume (+35%) and ASP (+10.6%) underpinned by new capacity from NGC and improvement in operation efficiency and strengthening of the USD against MYR. Correspondingly, PBT rose 70% as margin expended to 19.5% in 1Q18 from 16.9% in 1Q17 due to increase in sales volume and ASPs, strengthening of USD and improvement in operation efficiency. This brings PATAMI to RM96.4m (+72% YoY).

Outlook. Looking ahead, due to the pent-up demand for rubber gloves, Plant 1, 2 and the recently completed plant 3 (in June 2017) are presently fully utilised. We expect volume sales to surge following the lower average input latex cost in tandem with falling raw material latex price. We believe margins will return to normalcy in subsequent quarters assuming minimal impact from charging of capex expenses. Presently, In anticipation of higher demand, Hartalega will begin commissioning the first production line at Plant 4 in August 2017 and the remaining production lines will be commissioned progressively. Plant 4 is scheduled to complete in 1Q CY2018 will add an estimated c.4b pieces (+18%) and provide the much-needed boost to FY19 earnings.

Maintain OUTPERFORM. Our TP is RM7.70 based on 29.5x CYE18E EPS (+1.0 SD above 4-year forward mean). 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) its dominant market positioning in the booming nitrile segment.

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

Source: Kenanga Research - 09 Aug 2017