This article first appeared in The Edge Financial Daily, on April 7, 2016.

Hartalega Holdings Bhd
(April 6, RM4.76)
Maintain hold with a lower target price (TP) of RM4.75 from RM5.68: The first phase of the next-generation integrated glove manufacturing complex (NGC) is now fully operational, increasing capacity (since January 2015) by 67% (nine billion pieces) to 22.4 billion pieces per annum. 

The NGC will host six plants, which will expand production capacity to 41.8 billion pieces per annum by financial year 2022 (FY22). 

The group is aiming to commission new lines progressively in Phase 2 (nine billion) beginning August 2016, a two-month delay due to various factors. The group will be deferring the construction of Phase 3 (nine billion) for now, with the aim to secure more orders first. 

Its margins have been on a downtrend for the past few quarters due to intensifying competition in the nitrile segment and the company’s eroding pricing premium. 

With more nitrile capacity coming on board in the sector and for the group, we believe that margins will continue to be under pressure as pricing competition intensifies. 

We expect earnings before interest, taxes, depreciation and amortisation margins to further decline by an additional 0.5% to 1.2%, to 27.1% to 28.2%, but believe any further decline from our projections are unlikely, thanks to better cost efficiencies from the NGC. We opine that management has anticipated the decline in margins and is focusing on increasing sales volume. 

This is expected to support its earnings growth, which we estimate to be 12.3% to 32.9% for FY16 to FY18 forecast (FY18F).

The group is looking to widen its presence in southern European countries (currently less than 1% of revenue), while doubling its sales workforce to 40.

We lower our FY16 to FY18F earnings forecasts to take into account more intensifying pricing competition in the nitrile segment, lower US dollar/ringgit assumptions (RM4.10/RM3.90/RM3.85 for FY16/FY17/FY18) and a delay in NGC expansion plans. 

Following our earnings forecast revisions, we are currently below Bloomberg consensus expectations by 1% to 7.8% for FY16 to FY18F earnings per share (EPS). 

Our “hold” call is unchanged, but we lower our TP to RM4.75, based on 22 times calendar year 2017 forecast EPS from 23 times as we remove the 10% premium owing to intensifying pricing competition and an eroding pricing premium. 

Although we like the group’s long-term prospects and solid fundamentals, we believe its earnings growth on capacity expansion will be mitigated by lower margins and gestation costs from new plants. 

The group is trading at FY17F price-earnings ratio of 24.2 times, which we believe reflects its earnings prospects. — CIMB Investment Bank Bhd, April 5