alliance hartalega 1q2014

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(Member of Alliance Bank group) PP7766/03/2013 (032116)

7 August 2013

1QFY14: A slow start Hartalega made a slow start to FY14, with annualised 1QFY14 core earnings making up 90.2% and 95.4% of house and consensus full year estimates. We anticipate earnings growth to pick up in the remaining quarters, underpinned by new production capacity from Plant 6 (completed in July 2013). However, we believe recent strong share price performance has largely priced in the positives mentioned above. With no near term positive catalysts insight, we take this opportunity to downgrade Hartalega from buy to NEUTRAL, with a higher TP of RM6.84 (+0.4%), based on 18x 12-month forward P/E. Although we remain positive on Hartalega’s long-term prospect, we foresee limited upside from current share price.

A slow start but expected to catch up in the remaining quarters Hartalega’s 1QFY14 results came in largely within expectation, with annualised core net

profit making up 90.2% and 95.4% of ours and consensus full year forecasts. We believe the earnings growth will pick up in the remaining quarters, as Plant 6 was fully completed only in July 2013, increasing overall group capacity by 30%.

1QFY14 revenue grew by 12.2% y-o-y and 3.1% q-o-q, underpinned by higher sales volume (+22.8% y-o-y, +5.2% q-o-q) which was partially offset by lower ASP (-10.4% y-o-y, -0.4% q-o-q) due to softer latex cost (-33.0% y-o-y, -17.7% q-o-q). 1QFY14 sales volume represents 22.8% of our full year estimates.

In terms of absolute core PBT, the group achieved RM29.2 per thousand gloves in 1QFY14 (-4.6% y-o-y, -4.3% q-o-q), mainly due to :- (1) Volatile foreign exchange rate during the quarter with high and low hitting RM3.22 and RM2.96/USD, although the average exchange rate recorded only -0.2% q-o-q, and (2) Stiffer price competition. Nonetheless, this is in line with our full year estimates of RM29.5 per thousand gloves for FY14

As usual, no dividend declared during the first quarter of the financial year.

Nitrile gloves still enjoy cost advantage of more than 24% in Aug 2013 Going forward, Hartalega anticipates global demand for nitrile gloves to remain stronger

than natural rubber (NR) gloves. Based on our estimate, nitrile gloves’ cost advantage against NR glove has widened from 17% in April 2013 to 24% in Aug 2013.

Apart from that, Hartalega plans to manufacture specialty gloves, and thus, expanding and enhancing its product mix. This expansion is expected to be carried in concurrent with NGC (next-generation glove manufacturing complex) project. We currently do not build in any earnings contribution from this expansion yet.

In terms of product innovation, Hartalega has invented and patented new coating products, called “Coats”, which it expects will create new niche market in healthcare, and potentially in the beauty and cosmetic sectors. This oatmeal glove is so far the only lab-proven anti-bacterial glove that is capable of moisturising the skin to make it soft and supple, which appears to be a value-added service in the healthcare industry.

On foreign shareholdings level, it has increased from 15.9% in April 2013 to 16.3% in July 2013. Lastly, management has also revealed that the group will appoint one of the top 4 audit firms, Deloitte & Touche as a replacement to its existing external auditors, Baker Tilly.

Forecasts unchanged As results came within expectation, we leave our forecasts unchanged.

Hartalega Holdings Neutral↓ Glove Bloomberg Ticker: HART MK | Bursa Code: 5168

Results Review

Analyst Ian Wan [email protected] +603 2604 3919

12-month upside potential Previous target price 6.80 Revised target price 6.84 Current price (as at 6 Aug) 6.79 Capital upside (%) 0.8 Net dividends (%) 2.5 Total return (%) 3.3

Key stock information Syariah-compliant? Yes Market Cap (RM m) 5,017.1 Shares outstanding (m) 738.9 Free float (%) 37.9 52-week high / low (RM) 6.80 / 4.16 3-mth avg volume ('000) 796.6 3-mth avg turnover (RM m) 4.9 Share price performance 1M 3M 6M Absolute (%) 4.6 20.5 48.4 Relative (%) 3.9 19.3 34.2

Share price chart

Results Review | Hartalega Holdings | 13 August 2013

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Downgrade to NEUTRAL with a higher TP of RM6.84 (+0.4%) Hartalega’s share price has performed very well, appreciating 39% since our upgrade on

7 Nov 2012. Although we remain positive on Hartalega’s long term prospects, underpinned by its strong competitive advantage (superior profitability) and potential game-changing NGC project which will drive its earnings growth from FY15 onwards, we believe current share price has largely priced in the positives mentioned above, at least for the next 12 months.

With no near term positive catalysts insight, we downgrade the stock from buy to NEUTRAL, with a higher TP of RM6.84 (+0.4%) as we roll forward our 12-month forward valuation (Aug 2013-July 2014) with an unchanged target P/E of 18x.

Key risks include delay in capacity expansion, especially the NGC plant.


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SNAPSHOT OF FINANCIAL RESULTS

Figure 1 : Results commentaries

1QFY14 1QFY13

% y-o-y change

% q-o-q change Comments

Key financial highlights Revenue (RM m) 278.0 247.7 12.2 3.1 1QFY14 revenue growth was mainly driven by sales volume growth (+22.8% y-

o-y and +5.2% q-o-q) which was partially offset by lower ASP (-10.4% y-o-y and -0.4% q-o-q) as latex cost eased.

Operating profit (RM m) 81.8 70.0 16.8 0.5 Pretax profit (RM m) 81.9 69.9 17.2 0.7 Net profit (RM m) 62.9 53.4 17.9 1.0 Core profit (RM m) 62.9 53.4 17.9 0.9 Q-o-q core net profit growth came in weaker than top line, mainly due to (1)

volatile foreign exchange rate during the quarter (RM2.96-3.22/ USD), and (2) stiffer price competition.

Per share data EPS (sen) 8.6 7.3 17.2 0.5 Core EPS (sen) 8.6 7.3 17.2 0.4 Annualised core EPS represents 90.2% and 95.4% of ours and consensus full

year forecasts. Net DPS (sen) - - BV/share (RM) 1.10 0.89 Margins Pretax (%) 29.5 28.2 Core profit (%) 22.6 21.5 Other highlights Utilisation rate (%) 91.2 89.5 Utilisation rate remains high at 91%.

Sales volume (bn pieces) 2.8 2.3 22.8 5.2 1QFY14 sales volume represents 22.8% of our full year estimate. We expect volume to pick up in the remaining quarters as plant 6 (+30% capacity) fully completed in July 2013.

ASP (RM/ k gloves) 96.9 108.1 -10.4 -0.4 ASP declined due to lower input cost. Average blended latex price (RM/kg)

7.8 11.7 -33.0 -17.7

Absolute core PBT/k gloves (RM)

29.2 30.6 -4.6 -4.3 Absolute core PBT per thousand gloves contracted by 4.6% y-o-y and 4.3% q-o-q, implying stiffer price competition. Nonetheless, this is within our expectation.

USD:MYR 3.08 3.12 -1.4 -0.2 USD against Ringgit has been very volatile during the quarter with the high and low hitting RM3.22/USD and RM2.96/USD respectively, although the average exchange rate for the quarter implying another way, which is -0.2% q-o-q.

Source: Company, Alliance Research


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Figure 2 : Key financial data

FYE 31 March FY12 FY13 FY14F FY15F FY16F Revenue (RM m) 931.1 1,032.0 1,263.5 1,368.6 1,741.1 EBITDA (RM m) 288.2 336.2 408.9 447.6 550.5 EBIT (RM m) 259.2 299.4 363.3 386.2 476.2 Pretax profit (RM m) 258.4 304.1 363.7 386.8 477.2 Reported net profit (RM m) 201.4 233.3 279.1 296.8 366.1 Core net profit (RM m) 201.4 233.4 279.1 296.8 366.1 EPS (sen) 27.6 31.9 37.4 38.9 46.5 Core EPS (sen) 27.6 31.9 37.4 38.9 46.5 Alliance / Consensus (%) 105.8 101.8 108.8 Core EPS growth (%) 5.4 15.4 17.3 3.8 19.6 P/E (x) 24.6 21.3 18.1 17.5 14.6 EV/EBITDA (x) 8.0 14.0 12.1 11.6 9.6 ROE (%) 32.5 30.6 27.4 24.1 23.1 Net gearing (%) Net cash Net cash Net cash Net cash Net cash Net DPS (sen) 12.5 11.0 16.8 17.5 20.9 Net dividend yield (%) 1.8 1.6 2.5 2.6 3.1 BV/share (RM) 0.85 1.04 1.37 1.61 2.01 P/B (x) 8.0 6.5 5.0 4.2 3.4

Source: Alliance Research, Bloomberg

Figure 3 : Nitrile butadiene rubber cost advantage widens to 24% vs natural rubber in Aug 2013

*Adjusted for latex content for nitrile butadiene rubber (45%) and natural rubber (60%).

Source: Bloomberg data, Alliance Research

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Figure 4 : Hartalega P/E Band Figure 5 : Hartalega P/B Band

Source: Bloomberg data, Alliance Research Source: Bloomberg data, Alliance Research

Figure 6 : Quarterly sales volume growth Figure 7 : Quarterly capacity utilisation rate

Source: Company data, Alliance Research Source: Company data, Alliance Research

Figure 8 : 1QFY14 revenue breakdown by product Figure 9 : 1QFY14 revenue breakdown by market

Source: Company data, Alliance Research Source: Company data, Alliance Research

PE BAND

Min: PER -1Std: PER Avg: PER +1Std: PER Max: PER

3.1 x 7.0 x 10.9 x 15.1 x 19.4 x

0.300.701.101.501.902.302.703.103.503.904.304.705.105.505.906.306.707.107.50

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Nitrile glove NR glove Overall q-o-q growth

78.0%79.0%80.0%81.0%82.0%83.0%84.0%85.0%86.0%87.0%88.0%89.0%90.0%91.0%92.0%

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Annualised capacity (bn pieces) Utilisation rate

NR glove, 6.7%

Nitrile glove, 93.3%

N.America, 54.0%

S.America, 3.5%

Europe, 29.6%

Asia, 10.6%

Oceania, 2.2% ROW, 0.2%


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DISCLOSURE

Stock rating definitions Strong buy - High conviction buy with expected 12-month total return (including dividends) of 30 or more Buy - Expected 12-month total return of 15 or more Neutral - Expected 12-month total return between -15 and 15 Sell - Expected 12-month total return of -15 or less Trading buy - Expected 3-month total return of 15 or more arising from positive newsflow. However, upside may not be sustainable

Sector rating definitions Overweight - Industry expected to outperform the market over the next 12 months Neutral - Industry expected to perform in-line with the market over the next 12 months Underweight - Industry expected to underperform the market over the next 12 months

Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date


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alliance hartalega 1q2014

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