Hartalega Holdings - Competition setting in HOLD

-  We maintain our HOLD recommendation on Hartalega Holdings Bhd (Hartalega), with an unchanged fair value of RM5.10/share, based on a fully-diluted PE of 14x FY14F earnings.

-  For the nine months to 30 December 2012, Hartalega posted a net profit of RM172mil (+14% YoY), meeting both ours, and street estimates. Sequentially, its 3QFY13 earnings grew 3% to RM61mil, from RM59mil in 2QFY13.

-  The company has declared a second interim dividend (singletier) of 3.5 sen per share, bringing total FY13F gross DPS declared to 7 sen. This makes up 53% of our forecast gross DPS for FY13F.

-  Despite the 6% drop in ASPs as a result of:- (1) intensifying price competition in the nitrile segment and (2) strengthening ringgit, Hartalega managed to grow its topline by 2% QoQ (+10% YoY). The decline was more than offset by an increase in sales volume of 8% (YoY: +23%), in line with increased nitrile glove penetration in the US (9MCY12’s 82% vs. 2011’s 68%), Hartalega’s core market (57% of revenue).

-  We also note that Hartalega’s sales mix (nitrile:latex) has shifted from the historical 95:5 to 93:7 as its OBM business in Asia (YoY: +1ppt contribution to revenue) took flight. We are somewhat positive on this development given that getting its foot in the door is Hartalega’s main priority now.

-  Hartalega’s EBITDA margin was flat at 29% for both QoQ and YoY (+1ppt) comparisons (historical average: 32%). Its revenue improvement did not filter down to its bottom line as 9MFY13 operating expenses continued to escalate (+2% QoQ,  +10% YoY). While we expect EBITDA margins to be further compressed moving forward (~28% for FY14F), we gather that it will also be supported by improving operating efficiencies.

-  The main culprit in the cost inflation was labour expenses, which grew 2ppts QoQ to make up 11% of operating costs (previously, 9%). Hartalega had taken on additional workers for its factories in anticipation of Plant 6 (4 more lines to be commissioned by July 2013) and Plant 7 (NGC). 

-  With regard to the minimum wage ruling, we understand that the incremental rise will be fully passed on to its customers with ASPs rising by 2%-3% in 4QFY13.

-  The recent government decision to transfer the burden of foreign worker levy to employees will be positive for the sector. For Hartalega, this translates into a gain of ~RM3.5mil. 

-  In our view, there is limited upside to Hartalega’s share price, given the run-up last year (+68%) coupled with the pricing in of anticipated growth for the next two years.

Source: AmeSecurities