Hartalega’s 1HFY16 (Mar) earnings were in line, making up 47% and 45% of our and consensus estimates respectively. Maintain NEUTRAL, with a revised TP of MYR5.36 (from MYR4.56, 3% upside). Although it booked a MYR21.6m FX-related loss during the quarter, it will benefit from the Reinvestment Allowance (RA), which would reduce itseffective tax rate going forward.

Earnings dip 3.6% QoQ. 2QFY16 revenue grew 18.4% QoQ, led by a 15.2% QoQ increase in sales volume. Nevertheless, 2QFY16 earnings contracted 3.6% QoQ, led by the recognition of a MYR21.6m fair value loss on FX derivatives which was due to the increase in average FX forward contract period to six months from the previous two months in April. Hartalega guided that the average FX forward contract policy would return to the default two months in 2HFY16. Management revised down its FY16 effective tax rate guidance to 19-21% from 24% previously (2QFY16: 19.3% vs 2QFY15: 25.6%) due to the utilisation of capital allowances (CA).

Updates & Forecasts. Commissioning of lines at the Next Generation Complex’ (NGC) Plants 1 & 2 has been marginally delayed by two months due to the redesign of production lines to reduce natural gas dependency. Subsequently, the commissioning of Plants 3 & 4 will also be delayed by three months to Jul 2016; we expect Hartalega to reach 31.5bn capacity by FY18 (3-year 25.3% CAGR). Management deferred its guidance on the MYR20m ESOS expenses to FY17/18 from FY16; further, it shed some light on the Reinvestment Allowance (RA), guiding that the NGC would start to enjoy the tax benefit from 4QFY17 onwards, which would result in a lower effective tax rate. Coupled with the revision of our FY16/FY17 USD assumption to MYR4.09/MYR4.33, we upgrade our FY16F-18F earnings by 2-10%; we show our revenue and cost assumptions in Figure 5 and 6. Hartalega also declared an interim DPS of 2 sen.

Maintain NEUTRAL with a TP of MYR5.36 (CoE: 8.7%, TG: 2%) which implies a 30.5x FY16F P/E (Figure 3). Hartalega is currently trading at 29.8x FY16F P/E, slightly below its historical 2SD trading band of 31x; while we are positive on Hartalega’s prospects, we remain cautious on the rich valuations. The main downside risk to our call would be further delays in expansion as well as unfavorable movements in the MYR and raw material prices. The key upside risk remains the re-rating of the sector driven by liquidity, despite the lack of new catalysts.