• Better revenue expected in FY18

• Demand to improve despite increase in ASPs

• Capacity expansion on track

• Price competition has abated amongst glove producers

• Earnings forecasts for FY17-18F lifted by +6.8% and +23%

• Maintain NEUTRAL with a revised TP of RM5.07

Better revenue expected in FY18. After going through a period of consolidation and various hikes in production costs last year, we are expecting Hartalega to record better revenue in FY18 when compared against FY17. This improvement is expected to be driven mainly by two factors which are: (i) improvement in demand and; (ii) increase in average selling prices (ASPs). Improvement in demand is following the expected completion of its Plant 3 of NGC which will provide additional 4.7b pieces of annual gloves capacity while the increase in ASPs is due to the strengthening of USD against MYR and fluctuation of raw material prices. Management noted that it has, on average increased ASPs by more than >10% since January 2017 to accommodate rising input prices.

Demand to improve despite increase in ASPs. In addition to the increase in capacity, we are also expecting demand to come from the shift in orders from China to Malaysia due to China’s recent participation in the Paris Climate Agreement back in November 2016. This resulted in increase in price of gloves produced in China especially vinyl plastic gloves as the factories try to comply with environmental friendly practices as agreed in the Paris Climate Agreement. This has caused the price of vinyl plastic gloves to increase by approximately +30% which drove the switch from vinyl plastic gloves to rubber gloves.

Capacity expansion well on track. We understand from the management that the commissioning of the production lines in its Plant 3 of the NGC is well on track with more than one line commissioned per month. Hence, we expect the full-commissioning of Plant 3 to be completed on schedule which is slated to be in the 2H17. In addition, due to the expected improvement in demand, we are expecting the utilization rate after taking into consideration new production capacity to stabilise at around 85% throughout the year.

Price competition has abated, it is now a volume game. We reiterate our view that it is now a volume game as we think price competition between the glove makers has now abated. This is due to: (i) the increase in production capacity industry-wide; (ii) announcement of gas price hike schedule and; (iii) deferral of foreign worker levy policy which have reduced the uncertainty involving future costs. That said, we are well aware of external factors such as currency movements as well as fluctuating raw material prices that continue to pose as threats to earnings growth.

Earnings forecast. We are revising our FY17-18F earnings upwards by +6.8% and +23% respectively after we revised our assumption on the expected utilisation rates as well as ASPs for both financial years given the recent developments in the company and the glove industry. The key risks to our earnings are the: (i) adverse fluctuation of USD against MYR; (ii) rising raw material prices; and (iii) lower demand from customers.

Recommendation. Post earnings revision, we are maintaining our NEUTRAL call on Hartalega with a revised TP of RM5.07 per share. Our TP is derived via pegging our FY18F EPS of 21.1sen to PER18 of 24x, which is its five-year average PER. Despite the more positive outlook for Hartalega this year, we are still wary on the movements of the currency as well as raw material prices which could potentially hurt earnings. In addition, we think the call is fair given Hartalega’s lofty valuation currently at 28.1x FY17PER vs an average of below 20x for its peers. Furthermore, we opine that further significant stock price appreciation is limited as the price has appreciated to lofty levels and has been hovering at a narrow range of between RM4.54-4.94 for the past six months.

Source: MIDF Research - 10 Mar 2017