KEY INVESTMENT HIGHLIGHTS

• 1HFY21 earnings within expectation
• Net profit for 2QFY21 grew more than fivefold yoy to a record high of RM545.0m
• ASP likely to see a 40% to 50% spike in 3QFY21
• Raw material prices jumped but there is room to pass on cost
• Sustainable expansion plan ongoing
• Maintain BUY with an unchanged TP of RM22.96

1HFY21 earnings within expectation. Hartalega Holdings Berhad’s (Hartalega) 1HFY21 core net income (CNI) of RM764.7m came in within our expectation at 36.8% of our full year estimates and 37.5% of consensus’ full year forecast. We deem the results in-line as we expect stronger quarters ahead. An interim dividend of 3.85 sen was announced, bringing YTD DPS to 5.95 sen.

Net profit for 2QFY21 grew more than fivefold year-on-year to RM545.0m. This comes as revenue surged 89.7%yoy to RM1,346.0m. The higher sales is attributed to higher average selling prices (ASP), which was a result of the acute supply deficit amid the Covid-19 pandemic. Profit grew faster than sales due to economies of scale, favourable raw material prices during the quarter and improving production efficiency. Notably, utilisation rate has improved to 98% from 85% in the same quarter last year. As a result, net profit margin for the quarter grew by 25.8ppt yoy to 40.5%.

Quarter-on-quarter, net profit hiked by 148% qoq as revenue jumped by 46.3% increased by 15.5%qoq. The stellar performance can be attributed to a more than 30% jump in ASP and 4% increase in capacity in 2Q21 compared to the preceding quarter. The greater economies of scale also resulted in improved production efficiency and profitability. Net profit margin grew by 16.6ppt qoq as a result.

ASP expected to grow by 40%-50% in the coming quarter. Due to the unrelentingly high demand for gloves, ASPs are expected to climb further in the coming quarters. We believe that Hartalega is in a good position to further revise their ASPs upward as it has been adopting a more gradual increase in ASPs to minimise any potential disruption in its distribution compared to its peers. It has allocated 7% to 10% of its capacity for spot orders from new capacity, which has been taken up until July 2021.

Raw material prices jumped but there is room to pass on cost. In an analyst briefing, management shared that nitrile rubber cost has increased by more than 30% YTD and expect prices to trend upwards due to the surge in demand for raw material. We think that Hartalega will be able to pass on the cost of higher raw material prices quite easily given that is ASPs are still lagging behind its peers.

Supply-demand imbalance may continue for 3 to 4 years. Management estimates that demand may continue to outstrip supply up to CY2024 based on the expansion plans announced by the industry’s top players. This is premised on the high demand from developed nations by 30% and 100% increase in demand from developing nations. The shortage in raw material supply and man power supply locally will also limit the growth in rubber glove production expansion. Organic growth for demand is also expected to exceed the 8% to 10% expected before the Covid-19 pandemic.

Building capacity to meet demand. The group targets to build 10 production lines in plant 6 and 7 at NGC. To-date, it has spent RM2.0b for 6 out of the 7 plants at NGC with 72 production lines in full operation. The first line of plant 7 is expected to start in 4QCY20. The high speed lines in Plant 6 and 7 are expected to start production by 1QCY21. Follow the full completion of NGC, which is expected in 1QCY21, the group plans to expand its capacity by another 19 billion pieces p.a. from plant 8 to 11, coined as NGC 1.5, which is situated on a 60.6-acre parcel next to NGC. It targets to start the first line towards 4QCY21. Due to the shortage in labour, the group plans to free up headcount from its existing facilities and redeploy them to the new production facilities. It plans to reinvest in internal capabilities and to further improve production efficiency as well as automation further narrow the gap in labour shortage. Following that, management will plan the expansion of NGC 2.0 based on the market demand.

Earnings forecast maintained. We make no changes to our earnings estimates as we deem Hartalega’s results to be inline with our estimates.

Maintain BUY with an unchanged TP of RM22.96. Our TP is based on 39.0x FY22F EPS of 58.9 sen. The PER valuation for Hartalega is 0.5x SD above its 10-year average. We believe that the premium to its long-term PER average is justified given the business upcycle and improving profitability. We are still positive on the company’s outlook given the new record global cases and tight supply in the market.

Source: MIDF Research - 28 Oct 2020