1H18 PATAMI of RM209.7m (+65% YoY) came in above expectations at 52%/53% of our/consensus full-year forecasts. The positive variance from our estimate is due to higher-than-expected volume sales. Hence, we raise our FY18E/FY19E net profit by 10%/7% to take into account the higher volume sales. Correspondingly, our TP is raised from RM7.70 to RM8.30 based on unchanged 29.5x on CYE18 revised EPS. YTD, the share price has risen by 66%, which outperformed the KLCI (+6.7%). The new TP offers limited upside from the current price. Downgrade from OUTPERFORM to MARKET PERFORM.

Result highlights

QoQ, 2Q18 revenue fell 3% due to higher sales volume (+5%) which was offset by lower ASP (-8%). The higher volume sales were the result of full quarter contribution from Plant 3. In contrast, the lower ASP was due to lower input raw material price. 2Q18 PBT margin firmed 4.2pts to 23.5% from 19.3% in 1Q18 due to lower input raw material cost, including nitrile and latex and boosted by operational efficiency on economies of scale from higher capacity. This brings 2Q18 PBT to RM137.2m (+18.6%). Similarly, 2Q18 PATAMI came in at RM113.3m (+17.6% QoQ) due to a higher effective tax rate of 17.1% compared to 16.7% in 1Q18. A first interim dividend of 3.5 sen was declared, which is within our expectation.

YoY, 1H18 revenue rose by an impressive 41% due to higher sales volume (+34%) and ASP (+6%) underpinned by new capacity from NGC plant 4 and strengthening of the USD against MYR. Correspondingly, PBT rose 67% as margin expanded by 3.2ppts to 21.3% in 1H18 from 18.1% in 1H17 due to increase in sales volume and ASPs, strengthening of USD and improvement in operation efficiency. This brings PATAMI to RM209.7m (+64.6% YoY).

Outlook. Looking ahead, due to the pent-up demand for rubber gloves, Plant 1, 2 and 3 are presently fully utilised. In anticipation of higher demand, Hartalega has begun gradual commissioning of Plant 4 (six lines) in August 2017 and the remaining production lines will be commissioned progressively. We expect contribution from Plant 4 to drive 3Q18 earnings growth. Additionally, we expect a rubber glove ASP to hike in 3Q18 due to the Hurricane Irma, which has caused the prices of Butadiene, a feedstock in the production of nitrile latex to soar. Plant 4 is scheduled to be completed in 1QCY18 and will add an estimated c.4b pieces (+18%) and provide the much-needed boost to FY19 earnings.

We raised our FY18E/FY19E net profit by 10%/7% to take into account higher volume sales (+25% growth rate compared to 20% previously) underpinned by Plant 3 and gradually commercialisation of Plant 4.

Downgrade from OUTPERFORM to MARKET PEROFRM. Correspondingly our TP is raised to RM8.30 from RM7.70 based on unchanged 29.5x CYE18E EPS (+1.0 SD above 4-year forward mean). YTD, the share price has risen by 66%, which outperformed the KLCI (+6.7%). The new TP offers limited upside from the current price. As such we downgrade the stock from OUTPERFORM to MARKET PEROFRM. We like Hartalega for its superior margins, which is head and shoulders against industry peers and new capacity expansion to boost earnings. However, the stock is currently trading at rich 29x CY18 earnings compared to a net profit growth of 15%.

Risks to our call. Higher-than-expected volume sales and fasterthan-expected commissioning of new production lines.

Source: Kenanga Research - 8 Nov 2017