We are positive about Hartalega (HARTA) growth going forward underpinned by uptick in demand, cost savings initiatives and potential margins expansion from operating efficiency and better economies of scale from Plant 5. BUY with TP of RM5.85 based on 36x FY20E EPS. We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and cost reduction management, (ii) constantly evolving via innovative products development, and (iii) its booming nitrile gloves segment.

Tell-tale signs of a pent-up demand for nitrile gloves potentially on re-stocking activities judging by industry longer delivery lead times are pointing towards a better sequential quarter in 2QFY20. We understand that the robust demand for nitrile has led to longer delivery lead times (the time taken between order and delivery) which has risen to between 45 to 50 days as compared to 30 to 40 days. We are positive on stronger growth in subsequent quarters underpinned by uptick in nitrile demand, to be driven by re-stocking activities.

Due to the impact of trade war whereby effective Sept 1, a 15% tariff will be imposed on Chinese-made medical and vinyl gloves, local rubber glove players expect to see an uptick in demand for gloves of which the positive impact is expected to be felt from the Dec-ending quarter period. Theoretically, the tariff hike is expected to increase the price for Chinese-made gloves, which could compel a switch of US gloves demand to Malaysian glove players including HARTA where US accounts for an estimated 53% of total volume sales.

We expect volume growth from Harta’s capacity expansion averaging 26% per annum over the past seven years to more than offset any potential crimp in margins. The first line of Plant 6 (installed capacity of 4.7bn pieces) is targeted to commence commercial operations in 1Q20. Plant 7 is expected to be commissioned by 2H20, which will focus on small orders as well as specialty products with an annual installed capacity of 3.4bn pieces. We expect contributions from Plant 5 to drive FY20 earnings growth. All in, Plant 5, 6 and 7 will add a total capacity of 12.1bn pieces, raising installed capacity by 27% to 44.6bn pieces per annum.

Source: Rakuten Research - 23 Oct 2019