HARTA’s 1QFY24 results disappointed. It reiterated that the challenging business landscape will persist throughout 2023. We widen our FY24F net loss forecast by 28% to RM105m (from RM82m) but maintain our FY25F numbers. We trim our asset based TP slightly to RM1.85 (from RM1.90) and reiterate our UNDERPERFORM call.

HARTA’s 1QFY24 results disappointed. Its 1QFY24 net loss of RM52.5m already made up 64% of our full-year net loss forecast of RM82m and was a far cry from the full-year consensus net profit estimate of RM215m. The variance against our forecast came largely from a lower-than-expected sales volume.

QoQ, its 1QFY24 revenue fell 15% due to a lower sales volume (-26%) partially offset by a higher ASP (+15%). EBITDA losses narrowed to RM10m compared to a loss of RM311m in 4QFY23 due to: (i) the absence of a RM347m impairment loss hit by the decommissioning of Bestari Jaya’s production facility in 4QFY23, (ii) lower natural gas price (-16%), and (iii) reduced economies of scale, particularly, poor cost absorption, as its utilisation rate continued to remain weak at 41% compared to 55% in 4QFY23. As a result, 1QFY24 losses shrank to RM52.5m compared to RM320m in 4QFY23. No dividend was declared in 1QFY24 which came in within our expectation. YoY, 1QFY24 revenue dropped 48% due to lower ASP (-11%) and volume sales (- 42%). This brings 1QFY24 net loss to RM52.5m compared to a profit of RM88m in 1QFY23.

The key takeaways from the analysts briefing yesterday are as follows:

1. The group is mindful that the prospect of raising ASP further in subsequent quarters is challenging due to the current massive overcapacity situation, with only a handful of customers agreeing thus far. In fact, ASP is expected to be lower in the next two quarters following the sequential weakness in natural gas price. Since natural gas price has declined sequentially in 2QCY23 (1QFY24), typically glove players have to pass on the cost savings to customers. However, due to the current competitive pressure emanating from massive oversupply and low industry utilisation averaging 40%, customers can walk away and choose to buy from other players whenever there is an attempt to raise prices. Case in point, buyers can turn to Chinese manufacturers which are still selling below USD20 per 1,000 pieces at USD15-17 per 1,000 pieces.

2. While it is hopeful that sales volume has bottomed, it is uncertain when demand is expected to return. Taking stock, the group received mixed responses in terms of customer inventory levels. Some customers are still stuck with high inventories while others are beginning to slowly restock. Generally, there is no urgency for buyers to place sizeable orders or hold substantial stocks as supply is plentiful and readily available.

3. The group is of the view that despite capacity rationalisation expected to continue, the challenging landscape is likely to persist. The group will continue to emphasise better cost management, improve operational efficiencies and scale up automation initiatives. Specifically, the loss in capacity of 13b pieces per annum from decommissioning the Bestari Jaya (BJ) production facility is expected to be gradually replaced by newer plants in NGC 1.5 which is expected to see better margins than the ageing BJ plants.

Outlook. We expect the operating environment to remain challenging in subsequent quarters, plagued by massive oversupply. Nevertheless, we expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants. Based on our estimates, the demand-supply situation will only start to head towards equilibrium in 2025 when there is virtually no more new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum underpinned by rising hygiene awareness. MARGMA projects 12%-15% growth in the global demand for rubber gloves annually from 2023, following an estimated 19% contraction to 399b pieces in 2022. It believes the supply-demand equilibrium may return in 6-9 months. However, we beg to differ, expecting the overcapacity situation to persist at least over the next 12 months. We project the demand for gloves to rise by 15% in 2023, which is consistent with MARGMA’s forecast. On the supply side, we are now factoring in a reduction of 24b pieces (previous reduction was 21b pieces) of gloves in the system by end- FY23. This will result in an excess capacity of 112b pieces (instead of rising by 4% or 116b as previously forecast) which is similar to CY22. Despite the improvement, the overcapacity still persists which means low prices and depressed plant utilisation will continue to plague the industry in 2023.

Forecasts. We widen our FY24F net loss forecast by 28% to RM105m (from RM82m) as we reduce the utilisation rate to 35% from 40%. We maintain our FY25F earning forecast.

We reiterate our UNDERPERFORM call but nudge our TP down slightly by 5% to RM1.85 (previously RM1.90) based on 1.4x FY24F BVPS, at a 20% discount to the sector’s average of 1.7x charted during previous downturns in 2008-2011 and 2014-2015 as we believe the current downturn could be one of the deepest ever. There is no adjustment to TP based on ESG given a 3-star rating as appraised by us (see Page 3).

Key risks to our recommendation: (i) the industry turning the corner sooner on stronger-than-expected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (ii) industry consolidation reducing competition among players, and (iii) epidemic and pandemic occurrences.

Source: Kenanga Research - 10 Aug 2023