Macquarie Equities Research (MQ Research) increased Hartalega’s (HARTA) target price (TP) by 15.9% to RM19.70 despite downgrading the company’s rating to Neutral. MQ Research raises FY21-23E earnings per share (EPS) by 2% to 57% and believes HARTA’s share price to potentially hit MQ Research’s blue-sky valuation of RM28.30, supported by current acute market shortages.

Event

• MQ Research downgrades Hartalega to Neutral with an increased target price of RM19.70, on a target CY21E price-to-earnings ratio (PE) of 40x (from RM17.00 on a target PE of 51x). MQ Research believes valuation and earnings could remain elevated in the near term, potentially hitting MQ Research’s blue-sky valuation of RM28.30, supported by current acute market shortages. However, MQ Research believes investors should use the next uptick in the share price to begin trimming positions as average selling price (ASP) increases taper off into 4Q20, reducing the momentum of consensus upgrades. A stronger ASP narrative for 2H21 is required for MQ Research to remain positive on valuation.

Impact

• Strong demand continues. Similar to industry peers, Hartalega continues to have strong order enquiries. Spot orders are coming in for deliveries up to March 2021, indicating severe market shortages. Hartalega has standardised some of its lines to only produce one size/one colour to reduce downtime, resulting in c.5%-8% capacity gains.

• ASP increase higher than expected. MQ Research gathers that other glove producers have increased ASPs 20-30% MoM for August deliveries and are looking at a further 10-15% increase for September. Due to this market-driven ASP increase, MQ Research believes Hartalega still has room to raise its ASP, albeit at a lower level due to its higher exposure to MNC customers. As such, MQ Research raises its FY21/22/23E ASP assumptions by 25%/14%/3%.

• Can valuation stay elevated on strong quarterly earnings? In MQ Research’s view, share price and valuation are likely to remain elevated in the short term as MQ Research projects FY21E’s net profit will be 6x FY20E following the ASP increase. However, MQ Research believes that the peak of strong earnings in FY21E is unlikely to be repeated in following years given the expectation of a COVID-19 vaccine in mid-2021. As such, MQ Research lowers its target PER to 40x (+1SD) from 51x.

Earnings and Target Price Revision

• MQ Research raises FY21E/22E/23E EPS 57%/43%/2% to reflect a higher ASP. MQ Research also raises its target price to RM19.70 from RM17.00 with a lower target PE of 40x. MQ Research’s blue-sky and bear-case valuations are RM28.30 and RM10.90. 

Price Catalyst

• 12-month price target: RM19.70 based on a PER methodology.

• Catalyst: Quarterly earnings from 2Q FY21 onward.

Action and Recommendation

• MQ Research downgrades Hartalega to Neutral.

12-month Target Price Methodology

• HART MK: RM19.70 based on a PER methodology

Source: Macquarie Research - 3 Aug 2020