• Maintain NEUTRAL, new MYR2.11 TP from MYR1.65, 8% upside. We came away from our recent site visit feeling cautiously optimistic on Hartalega. Despite the lack of clarity on the period of customer inventory destocking, we stay upbeat on the industry’s favourable cost outlook in 2H23, particularly the lower gas tariff. We maintain our call pending more consistent customer demand. Our TP incorporates a 0% ESG premium/discount as its ESG score is in line with the country median.

• Key takeaway from manufacturing plant visit. HART expects utilisation to fall slightly in April from the current 50% as it hikes its ASP. The company is not planning to commission any new capacity in 2023 unless it witnesses a pick-up in utilisation rate. On a positive note, the gas tariff is expected to normalise, with the upcoming contract negotiations with vendors likely to be followed by another round of adjustments in 2H23.

• ASP. Industry-blended ASP was said to moderate slightly to USD20- 21/1,000 pieces from c.USD20-22 in the previous quarter. The pace of ASP decline remained in the low single-digits, which also suggests the ASP may have already bottomed. We also gather that domestic glove makers had engaged in cost pass-through initiatives (HART raised its ASP twice this year while Top Glove (TOPG MK, NEUTRAL, TP: MYR1) did it in Oct 2022).

• Demand. Malaysia’s rubber glove exports spiked 11% MoM in Dec 2022, probably due to the UK Government’s one-off National Health Service tender. This was followed by a 14% MoM decline in Jan 2023, which suggests the order trend is still patchy as clients remain reluctant to place bulky orders. That said, the industry players are still unable to ascertain the timing of glove distributors’ destocking activities. We believe glove distributors expect inventory levels to deplete over the next six months.

• Supply. Post the Dec 2022 results, we keep our 2022 industry supply assumptions unchanged – taking into consideration that no new capacity was added. We lower our 2023 industry supply assumptions to 397bn from 430bn, assuming glove-makers phase out obsolete production lines. Taking into account the current low industry utilisation rate of 30-40%, we expect the disciplined approach in commissioning new production lines to provide a temporary cushion to the glove makers’ profitability.

• Earnings revision and valuation. We maintain our earnings estimates but lower our weighted average cost of capital assumption to 8% from 10% (we trim Beta and equity risk premium to 0.87 and 9% from 0.9 and 11%) in view of a more balance risk reward outlook. Despite a recent rally, HART still trades at -1.6SD P/BV, below its pre-COVID-19 historical mean.

• Key risks. Uncertainties over gloves ASP, capacity expansions, utilisation rates, and raw material prices.

Source: RHB Research - 27 Mar 2023