We came back from a meeting with Hartalega (HARTA) feeling positive about its growth beyond 2Q20 underpinned by uptick in demand, cost savings initiatives and potential margins expansion from operating efficiency and better economies of scale from Plant 5. Our TP of RM5.85 is based on unchanged 36x CY20 EPS (at +1.0SD above 5-year historical forward mean). Reiterate OUTPERFORM.

Expect a better sequential 1Q20. For illustration purposes, we expect 1Q20 core PATAMI (results expected by mid-Aug 2019) of RM95m (+4% QoQ; -23% YoY) or at 19%/18% of our/consensus full-year forecasts due to a more favourable USD/MYR (+3% QoQ). We consider such results to be within our expectation as we are expecting better performance in subsequent quarters on the back of uptick in demand and potential margins expansion emanating from operating efficiency and better economies of scale due to increased capacity and higher volume sales.

Cost optimisation measures to enhance margins. With the rubber glove players, including HARTA, becoming aware of the intense competition since six months ago; over the last few months, they have implemented cost optimisation measures such as: (i) slowed new capacity expansion, (ii) cost reduction initiatives to maintain margins, including automation, and (iii) intensifying sales efforts to penetrate emerging economies. Having experienced various cycles of oversupply, HARTA is more pro-active in carrying out measures to mitigate competitive pressure. All in, we expect volume growth from Harta’s capacity expansion averaging 26% per annum over the past seven years to more than offset any potential crimp in margins.

Stage is set for a recovery in ASPs. More importantly, there are nascent signs of a solid uptick in demand for rubber gloves, which could potentially lead to higher ASPs for players in subsequent quarters, including HARTA. From our ground checks, demand for nitrile gloves is peaking up again whereby players’ new capacities are swiftly taken up. We believe this uptick in demand is turning positive and should be reflected in players bottom-line in subsequent quarters beyond 2Q 2019. Recall, the frantic pace of capacity expansion has resulted in a mild excess supply over the past two quarters for rubber gloves leading to ASPs compression and flattish or lower profits over the past two quarters.

Outlook. Looking ahead, Plant 5 of its NGC facility has fully commissioned by end 1H 2019. Construction of Plant 6 structure has started and the first line is targeted to commence commercial operations in 1Q 2020. Plant 6 will have annual installed capacity of 4.7b pieces. Plant 7 is expected to be commissioned by 2H 2020, which will focus on small orders as well as specialty products with an annual installed capacity of 2.6b pieces. We expect contributions from Plant 5 to drive FY20 earnings growth. 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 OUTPERFORM. We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and cost reduction management, (ii) constantly evolving via innovative products development, and (iii) its booming nitrile gloves segment. We keep our FY20E and FY21E earnings forecasts unchanged for now. Our TP of RM5.85 is based on unchanged 36x CY20 EPS (at +1.0SD above 5-year historical forward mean). Reiterate OUTPERFORM.

Risks to our call. Lower-than-expected ASPs, volume sales and longer-than-expected approval for its anti-microbial gloves.

Source: Kenanga Research - 1 Aug 2019