• Downgrade to SELL from Neutral, new TP of MYR1.36 from MYR4.98, 16% downside. Hartalega’s valuation premium over that of its peers may have narrowed. Meanwhile, it may be at risk of being excluded from the KLCI, and undergo a derating as a result of passive fund rebalancing. Nonetheless, the glovemaker still has stronger margins than its peers, due to its higher exposure to the nitrile glove segment. This report marks the transfer of coverage to Oong Chun Sung.

• ASP back to pre-pandemic levels. As per our channel checks, local glovemakers should not engage in a price war with their China counterparts, even though the latter is selling gloves at c.USD19 per 1,000 pieces (local ASP: USD24 per 1,000 pieces as of August, marking a difference of 21%). Note that gloves from China are still subjected to a 7.5% import tariff from the US – although this is expected to expire in end-November. There could be a potential downside risk of ASP erosion, if the United States Trade Representative abolishes the tariff on Chinese glove imports.

• Demand unlikely to pick up yet. The inventory levels of some prominent glove distributors were still high as of June (higher than pre-pandemic levels by c.30-50%) despite seeing some signs of depletion recently. The glove distributors’ inventory drawdown may take at least a year before easing to pre-pandemic levels – taking into consideration normalised demand and the lofty inventory levels of the glove distributors (inventory on hand could still last for another six months) As such, we expect global demand growth to remain sluggish, at 4% YoY and 6% YoY for 2023 and 2024.

• Supply. Industry supply remains high – at 429bn pieces by end-2022F, with the Malaysian top four producers accounting for 47% of global market share according to effective production capacity (or 201.7bn pieces). This also builds in our assumption of a delay in capacity commissioning towards 2H23, given the currently low industry utilisation rate of 50-60%. Encouragingly, the top four players’ inventories had depleted by 9% (on average) in the recent Jun/Aug 2022 quarter. However, the percentage of finished goods vs total inventories remains elevated, as per data from the companies’ annual reports.

• Earning revision and valuation. We slash FY23-24F revenue by 29% and 36%, and corresponding earnings by 44% and 53% to reflect the lower utilisation rates, deferred capacity expansion and higher raw material cost assumptions. We also change our valuation methodology to DCF from P/E, and ascribe a 0% ESG premium/discount to our intrinsic value.

• Key upside risks. Increase in glove ASPs, faster-than-expected capacity expansion, higher-than-expected utilisation rates, and cheaper-than- estimated raw material prices.

Source: RHB Research - 28 Sep 2022