We are positive on Hartalega (HART)’s growth prospect going forward, underpinned by demand uptick with nascent signs of a strong volume growth rebound. With the lacklustre demand of the past 12 months behind us, we see re-stocking activities ramp up as the current outbreak of the Wuhan virus enforces higher hygiene standards. TP is raised from RM6.00 to RM6.50 based on 39.5x FY21E EPS (at +1.0SD above 5-year historical forward mean). Reiterate OP.

Expect a 3rd consecutive quarterly earnings improvement. Tell-tale signs of pent-up demand for nitrile gloves, potentially on re-stocking activities based on industry longer delivery lead times are pointing towards a better sequential quarter in 3QFY20. For illustration purposes, assuming >90% utilisation rate, ASP of 9.6 sen/piece and net margin of 15%, we expect its 3QFY20 core PATAMI (results expected by early Feb 2020) of RM113m-RM120m (+9-+15% QoQ; -1%-6% YoY) due to higher volumes sales and full quarter contribution from plant 5 bringing 9MFY20 PATAMI to RM311m-RM318m or 65% of our/consensus full-year forecasts. Nevertheless, such results would be within our expectation as we are already expecting better performance in subsequent quarters on the back of an uptick in demand. We keep our FY20E and FY21E earnings unchanged.

Nitrile gloves' market share to gain momentum. Based on our analysis, we expect nitrile gloves to continue growing and grabbing market share from latex gloves. The growth in nitrile segment is evident. For illustration purposes, going forward, assuming nitrile:latex breakdown of 80:20 (current is 67:37) and based on estimated global demand of 324b pieces in 2020 (forecast for 2019 is 300b pieces and assuming 8% growth rate in 2020), this implies nitrile growth rate of 30% or an additional 51b pieces from switch to nitrile gloves. HART’s 2QCY19 results showed strong volume growth (+14% QoQ) indicating a solid recovery in demand. From our ground checks, demand for nitrile gloves is picking up again where players’ new capacities are being swiftly taken up. The application of higher standards of hygiene to rein in the outbreak of the new Wuhan virus is expected to help ramp up re stocking activities. Ceteris paribus, a 1% increase in volume sales will raise our FY21E net profit by 1.2%.

Capacity expansion on track. The first line of Plant 6 (installed capacity of 4.7b pieces) has commenced commercial operations and the remaining 11 lines are expected to be gradually ramped up. 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. 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 like HART for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above peers in terms of better margins and cost reduction management, (ii) constantly evolving via innovative products development, and (iii) its booming nitrile gloves segment. The lacklustre demand in the past 12 months coupled with the application of higher standards of hygiene as reinforced by the virus outbreak is expected to help ramp up re-stocking activities. TP is raised from RM6.00 to RM6.50 based on 39.5x (previously 37.5x) FY21E EPS (at +1.5SD above 5-year historical forward mean). 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 - 22 Jan 2020