KEY INVESTMENT HIGHLIGHTS

• 2QFY19 earnings came in at RM103.9m, in line with our expectation

• Sales volume grew by +8.2%yoy to 7.5b pieces as market demand picked up

• On the contrary, average selling price contracted further as competition in nitrile glove segment intensifies

• Declared first interim dividend of 1.8sen per share

• Maintain NEUTRAL with a revised TP of RM4.90

Earnings met our expectation. Hartalega Holdings Berhad’s (Hartalega) 2QFY20 earnings came in at RM103.9m. This brings its cumulative 1HFY20 earnings to RM197.9m which met ours but lagged consensus’ full-year FY20 earnings estimates at 45.3% and 41.2% respectively. Comparing on a year-on-year basis, 2QFY20 revenue staged a marginal declined of -0.7%yoy. Nonetheless, earnings declined by a staggering -13.6%yoy due to the higher operating expenses.

Inability to fully pass on higher costs. During the quarter-in-review, sales volume grew by +8.2%yoy to 7.5b pieces driven by the: (i) fully commissioning of Plant 5 and; (ii) increase in market demand. However, the higher sales volume was mitigated by the decline in average selling price (ASP) by -8.2%yoy to about RM95.0 per thousand pieces. The contraction in ASP was caused by the downward pricing pressure from the aggressive expansion of nitrile glove manufacturing capacity by fellow competitors. Consequently, earnings declined as the higher costs of labour, packaging and natural gas costs were unable to be fully passed on to customers in order to protect market share. On a positive note, the plant utilisation rate remains commendable at 85.0% (vs Q2FY19: 87.0%) despite the challenging operating environment.

Production capacity to improve by +22.0% by FY22. The group has set aside capital expenditure (capex) for plant expansion and automation of RM630.0m and RM115.0m respectively for the next three years. The capex for plant expansion is allocated for the construction of Plant 6 (4.7b pieces) and Plant 7 (3.4b pieces) which is targeted to start production in the 1QCY20 (FY20) and 2HCY20 (FY21) respectively. Note that Plant 7 will cater to smaller volume orders on specialty gloves. These products are expected to command a higher margin as compared to examination glove. Overall, annual capacity will increase from approximately 36.6b pieces to 44.7b pieces by FY22 (+22.0%).

First interim dividend declared. Hartalega declared its first interim dividend for FY20 of 1.8sen per share (vs FY19 of 2.2sen)

Impact to earnings. We are revising our FY20F and FY21F earnings estimates by +1.2% and +2.3% respectively as we take into account the higher utilisation rate of Hartalega’s plants despite the intense competition.

Target price. We are revising our target price to RM4.90 per share (previously RM4.77). This is derived via pegging our FY21F EPS of 15.8sen to PER21 of 31.0x, which is -1.0SD below its three-year average historical PER. We prescribed a discount to Hartalega’s historical PER valuation in light of the diminishing differential between its profit margins in comparison to its peers.

Maintain Neutral. We remain concern on the ASP contraction in view of the intensifying competition in the nitrile glove segment. The recent restoration of the supply-demand dynamic came at cost of lower ASP despite the picked-up in demand. In the near term, we believe that higher sales volume resulting from capacity expansion coupled with the cost optimisation effort will sustain earning growth. Furthermore, we take comfort that the group is working on finalising land acquisition for its future expansion plan beyond its current Next Generation Integrated Glove Manufacturing Complex (NGC) in Sepang. Valuation wise, the stock is currently trading close to PER of 36.0x. Therefore, we believe that all positivity has been priced in at current valuation and hence, limited upside for the stock. All things considered, we are maintaining our NEUTRAL on Hartalega.

Source: MIDF Research - 6 Nov 2019