Hartalega Holdings - On Track

Hartalega’s 1HFY13 net profit of RM111.9m was largely in line with our and consensus estimates. The commendable results were mainly attributed to higher sales, easing of raw material prices and higher efficiency in its production lines. Its expansion plan is on track, with total capacity expected to reach 13.5bn pieces p.a. by June 2013. We think that margin erosion is still a concern for the company as other major players are ramping up their nitrile gloves capacity but the full effect may only come in by 2HCY13. As we revise our earnings estimates and roll over our valuation, we derive a new FV of RM5.20 and upgrade our call to Trading BUY, backed by its potential decent earnings albeit with an embedded risk ofnarrower margins.

Results in line. Hartalega’s 2QFY13 results were largely in line with our and street estimates. Its revenue improved 3.0% q-o-q and 11.1% y-o-y, mainly attributed to an increase in sales volume, continuous expansion in its production capacity, as well as rising demand. Meanwhile, thanks to the easing of raw material prices of nitrile and natural latex, Hartalega was able to record a revenue growth of 9.7% q-o-q and 10.9% y-o-y. Although its EBIT margin has declined y-o-y mainly due to intense price competition, we reckon that the margin has actually improved slightly q-o-q, which we think was attributable to the enhanced efficiency at its production plants, coupled with a decline in ASP that was less than the easing of raw material prices.

Expansion plans on track. Hartalega started construction on its Plant 6 in February 2012 and to date, two out of the 10 production lines there have commenced operation. Upon the completion of Plant 6, the company’s production capacity is expected to swell by 3.5bn pieces p.a. to reach 13.5bn pieces p.a. by June 2013.

Margin erosion may get intense in 2HCY13. Although the company is ramping up its production with more innovated production lines, the emergence of new capacity in the nitrile gloves market may still create price competition among the glove makers and that may somehow impact its earnings margin. Nonetheless, we believe that its competitors’ capacity may materialise and pose a threat to Hartalega only by 2HCY13.

Model reviewed and earnings revised. We upgrade the company’s FY13 and FY14 earnings forecasts to RM230.3m and RM252.4m, from RM212.5m and RM246.7m respectively, after incorporating the additional production from Plant 6. Moving into FY14, we think that competition may become more intense due to the additional capacity entering the market and narrowing margins. As such, we forecast a slower earnings growth.

Upgrade to Trading BUY. We derive a new FV for Hartalega at RM5.20 as we roll over our valuation, pegging it at 15x FY14 PE. We believe that the company may be able to deliver decent earnings in the coming quarters, albeit with an embedded risk that its margin may be squeezed when the price competition gets more intense in 2HCY13. As such, we believe Hartalega deserves our Trading BUY recommendation.

Source: OSK