We are positive about Hartalega (HARTA) growth going forward 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 CY20E EPS (at +1.0SD above 5-year historical forward mean). Reiterate OP.

Expect a 2nd consecutive quarterly earnings improvement. Tell-tale signs of a pent-up demand for nitrile gloves potentially on re-stocking activities judging by industry longer delivery lead times are pointing towards a better sequential quarter in 2QFY20. For illustration purposes, we expect 2QY20 core PATAMI (results expected by early Nov 2019) of RM100m-RM110m (+6+17% QoQ; -8-17% YoY) due to higher volumes sales and full quarter contribution from plant 5 bringing 1HFY20 PATAMI to RM194m-RM204m or 38%/40% of our/consensus full-year forecasts. Nevertheless, such results would 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.

Stage is set for a recovery in volume sales for nitrile demand. We understand that the robust demand for nitrile has led to longer delivery lead times (the time taken between order and delivery) which has risen to between 45 to 50 days as compared to 30 to 40 days. We are positive on stronger growth in subsequent quarters underpinned by uptick in nitrile demand, to be driven by re-stocking activities.

Expect US demand to surge from trade-war effect. Due to the impact of trade war whereby effective Sept 1, a 15% tariff will be imposed on Chinese-made medical and vinyl gloves, local rubber glove players expect to see an uptick in demand for gloves of which the positive impact is expected to be felt from the Dec-ending quarter period. Theoretically, the tariff hike is expected to increase the price for Chinese-made gloves, which could compel a switch of US gloves demand to Malaysian glove players including HARTA where US accounts for an estimated 53% of total volume sales.

Capacity expansion on track. 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. The first line of Plant 6 (installed capacity of 4.7b pieces) is targeted to commence commercial operations in 1QCY20. Plant 7 is expected to be commissioned by 2HCY20, which will focus on small orders as well as specialty products with an annual installed capacity of 3.4b 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 OP. We keep our FY20E/FY21E earnings forecasts unchanged for now pending release of results expected by early Nov 2019. Our TP of RM5.85 is based on unchanged 36x CY20E EPS (at +1.0SD above 5-year historical forward mean). 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. Reiterate OP.

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

Source: Kenanga Research - 23 Oct 2019