This article first appeared in The Edge Financial Daily on October 24, 2019

Hartalega Holdings Bhd
(Oct 23, RM5.20)
Maintain outperform with an unchanged target price (TP) of RM5.85: We are positive about Hartalega Holdings Bhd’s growth going forward, underpinned by an uptick in demand, cost-saving initiatives and potential margin expansion from operating efficiency and better economies of scale at Plant 5. Our TP of RM5.85 is based on unchanged 36 times calendar year 2020 (CY20) earnings per share (at +1 standard deviation above its five-year historical forward mean).

For illustration purposes, we expect 2QFY20 core profit after tax and minority interests (Patmi) (results expected by early November 2019) of RM100 million to RM110 million (+6%-17% quarter-on-quarter; -8%-17% year-on-year) due to higher volume sales and a full-quarter contribution from Plant 5, bringing first-half (1H) of FY20 Patmi to RM194 million to RM204 million, or 38% and 40% of our and consensus full-year forecasts respectively.

Nevertheless, such results would be within our expectations as we are expecting better performance in subsequent quarters on the back of an uptick in demand and potential margin expansion emanating from operating efficiency and better economies of scale due to increased capacity and higher volume sales.

We understand that robust demand for nitrile has led to longer delivery lead times (the time taken between order and delivery) which has risen to between 45 and 50 days from 30 to 40 days. We are positive on stronger growth in subsequent quarters, underpinned by an uptick in demand for nitrile gloves, to be driven by restocking activities.

Due to the impact of the ongoing US-China trade war whereby effective Sept 1, a 15% tariff is imposed on Chinese-made medical and vinyl gloves, local rubber glove players expect to see an uptick in demand for gloves, of which the positive impact is expected to be felt from the December-ending quarter. Theoretically, the tariff hike is expected to increase the price of Chinese-made gloves, which could compel a switch of US glove demand to Malaysian gloves, including Hartalega where the US accounts for an estimated 53% of total volume sales.

We expect volume growth from Hartalega’s capacity expansion averaging 26% per annum over the past seven years to more than offset any potential crimp in margins. The first line of Plant 6 (installed capacity of 4.7 billion pieces) is targeted to commence commercial operations in 1QCY20.

Plant 7 is expected to be commissioned by 2HCY20, which will focus on small orders and specialty products with an annual installed capacity of 3.4 billion pieces. We expect contributions from Plant 5 to drive FY20 earnings growth. All in, Plants 5, 6 and 7 will add a total capacity of 12.1 billion pieces, raising installed capacity by 27% to 44.6 billion pieces per annum.

We like Hartalega for: i) its “highly-automated production processes” model, which is moving from “good” to “great” as they are head and shoulders above its peers in terms of better margins and cost reduction management; ii) constantly evolving via innovative product development; and iii) its booming nitrile glove segment.

Risks to our call are lower-than-expected average selling prices and volume sales, and a longer-than-expected approval for its antimicrobial gloves. — Kenanga Research, Oct 23