Tell-tale signs like normalising demand and intensified competition are pointing towards a potential slower set of sequential 2Q19 results. Anecdotal evidence suggests that shorter delivery lead time does indicate that strong demand is tapering-off and players ramping-up production could result in further ASP pressure. Reiterate UNDERPERFORM with an unchanged TP of RM5.15 based on 32.5x CY19 EPS.

Expect a slower set of sequential 2Q19 results. We expect core 2Q19 PATAMI (results release by Nov 2018) to be lower sequentially (1Q19 PATAMI: RM124.9m) due to; (i) normalising demand as delivery lead times have shortened, and (ii) competitive pressure. Ceteris paribus, assuming if volume growth and ASPs QoQ are both lower by 2% each, 2Q19 PATAMI could be lowered to RM119.9m (- 4% QoQ; +5.8% YoY) which will bring 1H19 PATAMI to RM243.9m (+16.3% YoY) or 50%/48% of our/consensus full year forecasts.

Potential competitive pressure. From our channel checks, we gather that competition in the nitrile gloves segment has intensified leading to pressures on ASPs. Note that generally rubber glove ASPs have risen by an average of 25% since end 2016. As such, coupled with the moderating demand and in anticipation of new capacities ramp-ups, we would not be surprised if ASPs come under further pressure over the next two quarters.

Shorter lead time indicating strong demand is tapering-off. We understand that the production of vinyl gloves in China has resumed and normalised in early 2018. Hence, we understand that over the past six months, delivery lead times (the time frame between order and delivery) have shortened from 60- 70 days as compared to 30-45 days, potentially indicating that strong demand is tapering-off.

Outlook. Looking ahead, the commissioning of Plant 5 has gradually commenced, starting from Aug 2018 with construction of Plant 6 in 1Q 2019. Two lines have commissioned in end Sept 2018. The remaining balance will be ready by end 1Q 2019. Plant 5 and Plant 6 will each have annual installed capacity of 4.7b pieces. Additionally, Hartalega plans to set up Plant 7, expected in March 2019, which will focus on small orders as well as specialty products. Plant 7 will have an annual installed capacity of 2.6b pieces. We expect contributions from Plant 5 to drive FY19 earnings growth. Once completed, Plant 5 is expected to boost additional capacity by 14.5% to 37.2b pieces per annum. All in, Plant 5, 6 and 7 will add a total capacity of 12.1b pieces, raising installed capacity by 27% to 44.6b pieces per annum.

Reiterate UNDERPERFORM. TP unchanged at RM5.15 based on an unchanged 32.5x PER (at +1.5 SD above 5-year historical forward mean) over CY19 EPS. We believe all the positives could have priced in with steep valuations of 42.0x and 38.3x FY19E and FY20E EPS. In the meantime, its net profit growth rates are only expected at 10%-9% p.a. over the next two years.

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

Source: Kenanga Research - 29 Oct 2018