Macquarie Equities Research (MQ Research) wrote a report on Hartalega following its announcement on the 96 acres land purchase for factory expansion. MQ Research summarized that the plant will likely only contribute to earnings in FY23E as construction begins in 2021. Though the movement control order (MCO) may spell some delays in Hartalega’s expansion, resulting in further shortage of gloves in the market, MQ Research maintains its Outperform rating on this glovemaker with a target price (TP) of RM7.10.

Event

• Hartalega announced plans to acquire 95 acres of land for total consideration of RM263m for the next phase of expansion and is set to commission the first line by 2HCY22. Apart from this, management also indicates current market is having shortage of gloves. This is in line with MQ Research’s investment thesis, which should lead to potential average selling price (ASP) increases and margin expansion.

Impact

• Acquisition details. The 95 acres of land are located at Banting, 32km away from existing Next Generation Integrated Glove Manufacturing Complex (NGC). As part of the deal, the vendor will convert the land into heavy industrial title and construct road infrastructure. This acquisition is targeted to complete by 2HCY22 and will be funded by internally-generated funds or bank borrowings. Assuming the RM263m is fully funded by bank borrowings, Hartalega’s gearing ratio raises from 10% to 20%.

• Replicating NGC 1.0 model. NGC 2.0 will have seven plants, which have total 32bn pcs capacity (+74%). This will bring total capacity to 76.0bn pcs in 2029. Plant construction is targeted to begin in 2021, which is concurrent with the vendor’s construction of road infrastructure. The first plant is expected to commission in 2H22. Hence, NGC 2.0 will only start contributing to FY23 earnings.

• Updates on COVID-19 impact. Management acknowledged that the market is experiencing a shortage of gloves due to the recent spike in COVID-19 infections. It also confirmed that it has been able to raise ASP to pass through higher operational costs. Hence, MQ Research reiterates its thesis on the shortages lead to margin expansion for all glove makers, including Hartalega.

• Impact from MCO. Plant 6 expansion is likely to experience some delay due to the 28 days of MCO. Recap, MQ Research’s initial expectation is to add another two lines from Plant 6 in April. Each line produces 0.39bn pcs/annum (1% of total installed capacity). That aside, supply of raw material and other packaging materials is not an issue during MCO as Hartalega has sufficient inventories and overseas sources.

Action and Recommendation

• MQ Research views rubber gloves as a staple within the healthcare industry, which MQ Research believes justifies the premium valuation for the sector. MQ Research reiterates an Outperform rating on Hartalega with a TP of RM7.10, which is based on +1.5 standard deviation of 43x. MQ Research’s top pick remains Top Glove (TOPG MK, RM6.11, Outperform, TP: RM7.35), which trades at 28x price-to-earnings ratio vs. Hartalega at 42x.

12-month Target Price Methodology

• HART MK: RM7.10 based on a Total Shareholders Returns methodology
• TOPG MK: RM7.35 based on a Total Shareholders Returns methodology

Source: Macquarie Research - 27 Mar 2020