Despite forecasting a 3-year EPS CAGR of 28%, we remain cautious on Hartalega, as we believe its current valuations have priced in the positive news. Earnings contribution from its aggressive capacity expansion at the NGC would help offset ASP pressure from higher costs as well as stiffer competition. Maintain NEUTRAL with a revised DCF-derived TP of MYR4.95 (from MYR5.23, 4% upside).

NGC powers growth. Hartalega is on track to fully commission Plants 1 and 2 of its Next Generation Complex (NGC) by March. Management expects the progressive commissioning (two lines per month over a one year duration) of Plants 3 and 4 to start from June onwards. In total, we forecast that the NGC would add 28bn gloves capacity to bring total annual capacity to 42bn pieces by 2021 (+200%). Earnings growth from the additional capacity would help offset pricing pressures from higher costs as well as stiffer competition.

Operational challenges. We believe that the increasing industry competition, particularly in the nitrile segment, would complicate the cost pass-through mechanics as manufacturers compete on price to maintain/take market share. We thus believe margins could face pressure from the removal of government subsidies (gas tariff increase) and labour cost increase (minimum wage and foreign labour levy hike). We also expect earnings to be dampened by the recent MYR strength. RHB has revised its 2016 USD forex assumption to MYR4.18 (from MYR4.34).

Earnings and risks. We revise our FY16F-18F earnings by -1% to 4% after updating our assumptions. The upside risks to our forecast include the re-rating of the sector, driven by liquidity buoyed by market risk aversion. On the downside, the key risk would be higher prices for raw materials such as latex and nitrile.

Maintain NEUTRAL. We continue to like Hartalega’s growth prospects (3-year EPS CAGR of 28%) where the additional capacity from the NGC should help offset ASP pressure from cost increases as well as tougher competition. Nevertheless, we believe that current valuations have reflected the positive news, as Hartalega trades at a premium to the sector on a P/E basis (Figure 4). Maintain NEUTRAL with a revised DCF TP of MYR4.95 (CoE: 9%, TG: 2%), which implies 23.7x 2016F P/E. Hartalega is trading at 2016F P/E of 22.8x, which is around its historical +0.5SD trading band of 22.4x.

Financial Exhibits

SWOT Analysis

Source: RHB Research - 22 Mar 2016