Hartalega Holdings Bhd
(May 19, RM8.20)
Maintain neutral with a target price of RM7.24: Management is quite optimistic of prospects for the financial year ending March 2016 (FY16) and expects growth to be mainly supported by additional capacity from the next generation integrated glove manufacturing complex (NGC).

Currently, the NGC is constructing the production lines for Plants 1 and 2. According to management, the installation of production lines in these two plants is on track and should be completed by the end of calendar year 2015 (CY15) or early CY16. 

With the completion of these two plants, Hartalega’s total capacity will increase by approximately 4.2 billion pieces of gloves, translating into an annual capacity of 18.4 billion pieces per annum. 

Barring unforeseen challenges, management expects to complete the construction and installation of the NGC by 2020 which will house an annual capacity of 35.3 billion pieces per annum.

The group also expects to launch a new product in the second half of CY15. 

This new product will be in the surgical gloves line and will be produced at the NGC.

The company noted that it is positive on this market because the demand for this type of glove is high, but the supply is low due to stringent manufacturing and quality requirements.

With rising labour costs, the group expects to be able to reduce the number of unskilled workers and replace them with more skilled workers. This is part of management’s strategy to increase productivity. 

As at May this year, Hartalega’s productivity is 17% higher than its peers with only 3.9 workers per million pieces of gloves (wpmpg) produced per month.

The other listed peers have an average of 4.7 wpmpg per month and the total sector average is 7.5 wpmpg per month.

Hartalega’s own brand manufacturing under the brand name “Gloveon”, has been expanding positively. 

It has expanded from 4% of its total sales in early establishment years to approximately 6% in FY15. 

This is mainly contributed by its sales to Australia which consists of 3% to 4% of its total sales. 

Currently, Gloveon has four overseas offices in Australia, the United States, China and India.

Going forward, the group expects to expand its market presence in France and Italy. 

In 2014, France and Italy experienced a surge in demand for nitrile gloves, growing by 34% and 18% respectively. 

This shows the potential of growing use of nitrile gloves which is expected to benefit Hartalega. 

Currently, the presence of Hartalega in France and Italy is minimal.

We are increasing our FY16 and FY17 earnings forecasts by 3.4% and 5% respectively.

Our revision in forecasts takes into consideration higher sales volume from the additional capacity of the NGC.

However, due to the increasing gas cost, we expect Hartalega to experience slight margin pressure.

Hartalega is currently trading at a 2016 price-earnings ratio (PER) of 29 times, which is the highest among its peers. 

Our valuation is based on a PER of 23 times the group’s forecast FY16 earnings per share (EPS) of 31.5 sen. 

We peg our PER target multiple to a one standard deviation premium over its five-year rolling average PER.

This is to capture the potential upside growth from the company’s new products and new production line. 

The valuation of glove companies spiked early this year after the decline in crude oil price, and the stronger US dollar against the ringgit. 

We do not think this elevated valuation is sustainable. In addition, we fully dilute our EPS as we expect a full warrant conversion as the strike price is very deep in the money at RM4.14 per share. — MIDF Amanah Investment Bank Bhd, May 19

This article first appeared in The Edge Financial Daily, on May 20, 2015.