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This article first appeared in The Edge Financial Daily on October 31, 2018

Hartalega Holdings Bhd
(Oct 30, RM6.23)
Underperform with an unchanged target price (TP) of RM5.15:
Tell-tale signs like normalising demand and intensified competition are pointing towards a potential slower set of sequential second-quarter 2019 (2Q19) results. Anecdotal evidence suggests a shorter delivery lead time does indicate strong demand is tapering and players ramping up production could result in further average selling price (ASP) pressure. We reiterate “underperform” with an unchanged TP of RM5.15 based on 32.5 times calendar year 2019 (CY19) earnings per share (EPS).

 

We expect core 2QFY19 profit after tax and minority interest (Patami) (results to be released by November 2018) to be lower sequentially (1QFY19 Patami: RM124.9 million), due to normalising demand as delivery lead times have shortened, and competitive pressure. Ceteris paribus, assuming if volume growth and ASPs quarter-on-quarter (q-o-q) are lower by 2% each, the 2QFY19 Patami could be lowered to RM119.9 million (-4% q-o-q; +5.8% year-on-year [y-o-y]) which will bring the first half of 2019 Patami to RM243.9 million (+16.3% y-o-y) or 50%/48% of our/consensus full-year forecasts.

From our channel checks, we gather that competition in the nitrile gloves segment has intensified leading to pressures on ASPs. Note that generally, rubber glove ASPs have risen an average of 25% since end-2016. As such, coupled with moderating demand and in anticipation of ramping up new capacities, we would not be surprised if ASPs come under further pressure over the next two quarters.

We understand the production of vinyl gloves in China has resumed and normalised in early 2018. Hence, we understand over the past six months, delivery lead times — the time frame between an order and delivery — have shortened from 60 days - 70 days, to 30 days - 45 days, potentially indicating strong demand is tapering.

Looking ahead, the commissioning of Plant 5 has gradually commenced, from August 2018 with the construction of Plant 6 in 1Q19. Two lines have been commissioned at end-September 2018, with the remaining ready by end-1Q19. Plants 5 and 6 will each have an annual installed capacity of 4.7 billion pieces. Additionally, Hartalega Holdings Bhd plans to set up Plant 7, expected in March 2019, focusing on small orders and specialty products. Plant 7 will have an annual installed capacity of 2.6 billion pieces. We expect contributions from Plant 5 to drive financial year 2019 (FY19) earnings growth. Once completed, Plant 5 is expected to boost additional capacity by 14.5% to 37.2 billion pieces per annum. All in, Plants 5, 6 and 7 will add a total capacity of 12.1 billion pieces, raising the installed capacity by 27% to 44.6 billion pieces per annum.

We reiterate our “underperform” rating, and an unchanged TP of RM5.15 based on an unchanged 32.5 times price-earnings ratio (at +1.5 standard deviation above five-year historical forward mean) over CY19 EPS. We believe all the positives could have priced in with steep valuations of 42 times and 38.3 times FY19 estimate and FY20 estimate EPS. Meanwhile, its net profit growth rates are only expected at 10% to 9% per annum over the next two years. The risks to our call are higher-than-expected volume sales and faster-than-expected commissioning of new production lines. — Kenanga Research, Oct 30.

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