3QFY16 results met expectations, making up 68%/70% of our/consensus estimates respectively. Maintain NEUTRAL with a revised DCF-based TP of MYR5.23 (5% upside). Despite minor hiccups during the quarter, we remain positive on Hartalega’s growth prospects and forecast a robust 28.6% EPS CAGR over the next three years. Nonetheless, we believe valuations have reflected the positive news as the stock is currently trading at the sector’s average PEG ratio.
The growth engine purrs. Hartalega’s Next Generation Complex (NGC)expansion plans are on track with the full commissioning of Plants 1 & 2 slated by 4QFY16 (Mar). Meanwhile, management expects Plants 3 & 4 to be progressively commissioned from 2QFY17 onwards, adding two lines per month over a 1-year period. In total, we forecast that the NGC would add a total of 28bn gloves to bring total annual capacity to 42bn pieces by FY22.
Operational challenges. 3QFY16 earnings were at the lower end of our estimates, hampered by a delay in the supply of Hartalega’s glove formers. Nonetheless we believe operations should normalise in subsequent quarters and as such, we expect a stronger 4QFY16. Management has also shared that the firm would be absorbing the incremental cost from the recent rise in minimum wage but passing on the impact of the increase in gas tariff to clients. Consequently, we trim our FY16F-18F earnings by 2-4%. Risks to our recommendation include heightened competition which could depress ASPs and a re-rating of the sector, driven by liquidity despite a lack of catalysts.
Maintain NEUTRAL. Although we remain positive on Hartalega’s growth prospects (3-year EPS CAGR of 28.6%), we believe valuations have reflected the positive news as the stock is currently trading at the sector’s average PEG ratio of 0.84x (Figure 5). Maintain NEUTRAL with a revised TP of MYR5.23 (CoE: 9%, TG: 2%), with an implied 2016 P/E of 25.8x.
Minor Hiccups But Better Days Ahead Forex gain/loss. Hartalega swung back to a positive forex gain of MYR0.7m (2QFY16: -MYR19.9m) as the USD ended lower in 3QFY16 at MYR4.29 (2QFY16: USD/MYR4.40). Recall that 2QFY16’s forex losses were primarily driven by a long-term USD hedge for a major client. Nonetheless, management has shared that going forward, it would be reducing the duration of its forex hedging to bring down the average forex hedging period.Margin outlook. Net margin rebounded in 3QFY16, off a lower base n the previous quarter (due to forex losses). Going forward, we believe that net margins could improve further as Plants 1 & 2 of NGC have started making positive contribution to group earnings. Meanwhile, we believe that the delay in the supply of glove formers that hampered production in 3QFY16 had prevented the full realisation of economies of scale as overhead costs were incurred but glove production was curtailed.
