Hartalega Holdings - A Price War Looms

Hartalega’s 1QFY13 revenue and earnings were within estimates, representing 23% and 24% of our and consensus numbers respectively. As we see nitrile gloves demand remaining resilient, we are upgrading our revenue forecasts by 16% and 19% for FY13-FY14 respectively. However, we also incorporate a profit margin erosion resulting from a potential price competition, as well as possibly higher operating costs due to electricity and gas price hikes, which are likely to be announced after the General Election (GE13). After trimming our earnings forecasts by 7% and 4% for FY13-14 respectively, the stock is downgraded to a Neutral, with FV of RM4.83, based on an unchanged 15x CY13 PER, from RM4.25 previously.

Within expectations. Hartalega’s 1QFY13 revenue and earnings of RM248m and RM53m respectively were largely in line with our and consensus forecasts. Revenue grew 13% y-o-y while net profit dipped 2%, no thanks to price competition between rubber glove makers. On a quarterly basis, the group registered a healthy net profit growth of 7% on the back of a marginal 3% rise in revenue. EBIT margin improved by 130bps, which we attribute to lower prices of raw materials, mainly latex, the price of which was 4% lower q-o-q. (average 1QCY12 price was RM7.46/kg vs RM7.16/kg in 2QCY12.)

Caution on margin erosion. Although latex price has pulled back by 9.4% since peaking at RM10.9/kg on 8 April 2011, the group’s EBIT and PBT margins shrank 4ppts and 2ppts respectively owing to price competition in the nitrile glove segment. In order to fulfill the strong demand for nitrile gloves, all four major glove players had ramped up their respective production capacity. We believe this may spark off a price war and pressure glove makers’ profit margins going forward. We gather that management will be more aggressive in pricing its nitrile gloves going forward in order to maintain its lion’s share in this market. As such, we are forecasting net profit margins of 21%-22%, down 4ppt from those achieved in FY10 and FY11. That said, we are also incorporating higher operating costs arising from rising electricity and gas prices, for which a hike is likely to be announced after the much-anticipated GE13.

Earnings forecast Revision.  In view of the resilient demand for nitrile gloves coupled with the group’s capacity expansion, we are upgrading our revenue forecast by 16% and 19% to RM1bn and RM1.1bn respectively for FY13-14. Nonetheless, by factoring in the potential margin erosion from the rising raw material costs and a potential price war, we are forecasting lower net profit margins of 21%-22%, from 26% previously for FY13-14.

Downgrade to NEUTRAL. Hartalega’s share price has rallied by some 25% over the past 8 weeks. In view of the 7% and 4% cuts in our earnings forecasts for FY13-14, we are downgrading the stock to NEUTRAL. Our FV is now at RM4.83, based on 15x CY13 PER.

Source: OSK