Hartalega (HART MK) Keeping An Eye On The NGC

Company Update, 7 March 2014
Hartalega (HART MK)
Neutral (Maintained)
Consumer Non-cyclical - Rubber Products
Market Cap: USD1,569m
Target Price:
Price:
MYR7.40
MYR6.85
Macro
Risks
Keeping An Eye On The NGC
Growth
Value
Hartalega (HART MK)
Relative to FTSE Bursa Malaysia KLCI Index (RHS)
136
6.5
127
6.0
119
5.5
110
5.0
102
4.5
9
8
7
6
5
4
3
2
1
93
Jan-14
7.0
Nov-13
144
Sep-13
7.5
Jul-13
153
May-13
8.0
Mar-13
Vol m
Price Close
0
0
.
2
0
0
We recently met up with Hartalega’s management and gather that .
0
construction on its next-generation integrated glove manufacturing 0
complex (NGC) is slated to begin in 4QCY14. While we are positive on 0
this venture, we believe that timely execution is key in bringing the
group back on the production growth path. Maintain NEUTRAL, with
unchanged TP of MYR7.40.



Source: Bloomberg
Avg Turnover (MYR/USD)
Cons. Upside (%)
Upside (%)
52-wk Price low/high (MYR)
Free float (%)
Shareholders (%)
Hartalega Industries Sdn Bhd
Employees Provident Fund
4.13m/1.25m
-22.9
8.0
4.80 - 7.68
70
50.3
6.5
Shariah compliant


2

.
2
0
.
2





NGC to lift earnings. During our recent meeting, Hartalega’s
management reaffirmed that the NGC is progressing as planned, with
construction of its first production line scheduled to commence in
4QCY14. The NGC, located in Sepang in Selangor, will consist of 72
production lines which would boost the company’s annual installed
capacity to 42.5bn pieces by 2020.
Nitrile demand to remain resilient. Given the prevalence of allergies to
natural rubber (NR) in the US, we continue to see the demand for nitrile
gloves rising over the next few years at the expense of NR. A decade
ago, NR gloves accounted for 81% of the examination gloves imported
into the US, while nitrile made up the remainder. Today, it is the reverse,
with nitrile gloves making up ~82% of all US glove imports in 2012. This
is to Hartalega’s benefit, as 90% of its production capacity is for nitrile
gloves.
Concerns over industry overcapacity are exaggerated. While we
believe that there is no over-capacity in the nitrile glove segment, we are
concerned about the impact on the segment’s declining average selling
prices (ASPs) as a result of intense price competition in the short-term.
Hartalega’s lead in nitrile technology and innovation will enable it to
maintain a margin premium over its peers, although competition will see
some erosion in their absolute margins.
Maintain NEUTRAL. We make no changes to our forecasts at this
juncture, and continue to like Hartalega for its: i) leading position in the
thriving nitrile market ii) highly automated production lines, and iii)
continuous efforts to improve operating efficiency. That said, we believe
that margins will continue to come under downward pressure due to
intensified competition in the nitrile glove segment amid declining ASPs.
Our unchanged TP of MYR7.40 is pegged to the existing 19x FY15 EPS,
which is +1.5SD of the stock’s historical 5-year trading band.
Forecasts and Valuations
Mar-11
Mar-12
Mar-13
Mar-14F
Mar-15F
Total turnover (MYRm)
735
931
1,032
1,189
1,316
Reported net profit (MYRm)
190
201
235
256
283
Recurring net profit (MYRm)
190
201
235
256
283
Recurring net profit growth (%)
33.0
5.8
16.7
8.9
10.6
Recurring EPS (MYR)
0.26
0.28
0.32
0.35
0.39
DPS (MYR)
0.11
0.09
0.15
0.16
0.18
The Research Team +603 9207 7668
Recurring P/E (x)
26.2
24.7
21.2
19.5
17.6
[email protected]
P/B (x)
10.1
8.0
6.5
5.5
4.7
P/CF (x)
26.9
24.9
15.7
15.4
16.0
Dividend Yield (%)
EV/EBITDA (x)
Return on average equity (%)
Net debt to equity (%)
1.5
1.3
2.1
2.3
2.6
18.8
17.1
14.5
14.3
13.0
44.8
net cash
Our vs consensus EPS (%)
36.2
net cash
33.9
net cash
30.6
net cash
1.1
28.8
net cash
0.9
Source: Company data, RHB estimates
See important disclosures at the end of this report
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1
Hartalega (HART MK)
7 March 2014
Revenue flattens as ASPs fall. Hhatalega reported mediocre 3QFY14 results on 12
Feb, mainly attributed to flat 3QFY14 revenue growth (-4.7% q-o-q; 3.2% y-o-y), as
well as average selling prices (ASPs) that were about 5% lower on the back of lower
material costs. On a YTD basis, its revenue of MYR826.8m and net profit of
MYR184.1m were 8.5% and 6.7% better y-o-y respectively, mainly attributed to better
operating efficiency, coupled with increased output from its new production lines at
Plant 6.
NGC to boost earnings. During our recent meeting with its management, Hartalega
reaffirmed that the NGC is progressing along as planned, with construction on its first
production line to commence in 4QCY14. Hartalega’s NGC in Sepang, Selangor will
consist of 72 production lines with a combined installed capacity of 28.5bn pieces.
This will boost the company’s annual installed capacity to 42.5bn pieces by 2020.
Figure 1 shows the gradual capacity from NGC combined with the existing Bestari
Jaya plant.
Figure 1: NGC capacity increase FY13 - FY22
N(bn pieces)
60
41.6
42.4
FY21
FY22
36.3
33.0
50
30.4
24.7
40
21.8
30
20
14.0
15.0
FY14
FY15
11.0
10
0
FY13
FY16
FY17
Bestari Jaya
FY18
FY19
FY20
NGC
Source: Company data
Management has allocated MYR1.8bn-MYR2.0bn in capex for its new facility,
Although the amount may seem substantial, we reiterate that the facility will be built
over eight years, and we believe that funding will not be an issue given Hartalega’s
operating cash flow of some MYR300m annually. All in, we maintain our positive
stance on the group’s capacity expansion, which is expected to increase 15%
annually over the next eight years as we believe that this would enhance the
company’s earnings visibility and production moving forward.
Nitrile demand to remain resilient. Due to the prevalence of NR-relatged allergies
in the US, we continue to see demand for nitrile gloves go up over the next few years
at the expense of NR. We gather that the switch is also due to advancements in
glove making technology, which has enabled glove manufacturers to produce nitrile
gloves which are ~66% lighter than NR gloves (3.0g nitrile gloves vs. 5.0g NR
gloves), which has in turn given them a cost advantage as less raw material is now
being used. According to industry statistics, in 2003, NR gloves accounted for about
81% of all examination gloves imported into the US, with nitrile making up the
remainder. Today, the reverse is true as nitrile gloves now made up some 82% of
US’ glove imports in 2012. We believe that the US is a good indicator of global rubber
glove demand given that it is the single largest glove user, consuming almost 30-35%
of all gloves produced in Malaysia.
See important disclosures at the end of this report
2
Hartalega (HART MK)
7 March 2014
Figure 2: US NR and synthetic glove imports (2003 - 2012)
(bn pieces)
35
30
25
20
15
10
5
0
2003
2004
2005
2006
2007
Natural rubber gloves
2008
2009
2010
2011
2012
Synthetic gloves
Source: MREPC
Sales grow steadily. We gather that nitrile glove demand is set to grow at 20%
annually over the coming years, and this is positive for Hartalega given its position as
the world’s largest nitrile glove producer, with an annual installed production capacity
of 14bn pieces. In tandem with the increase in synthetic gloves imports by the US,
Hartalega’s nitrile sales have risen by a CAGR of 61.8% since 2005. Note that the
group currently commands a 18% share of the nitrile glove market in the US.
Management expects sales volume for FY14 to grow by over 10bn pieces, which
would mean a 10-12% y-o-y increase from FY13. Moving forward, we expect
Hartalega’s sales to continue to improve given its healthy capacity expansion, with its
upcoming NGC as well as healthy growth of nitrile gloves demand from the US and
EU.
Figure 3: Hartalega's nitrile sales growth (FY05 – FY14)
(bn pieces)
10
9.4
9
7.8
8
7.8
7
5.9
6
5
4.3
4
3.1
3
1.5
2
1
0.2
0.3
FY05
FY06
0.7
0
FY07
FY08
FY09
FY10
FY11
FY12
FY13
9MFY14
Nitrile gloves
Source: Company data
See important disclosures at the end of this report
3
Hartalega (HART MK)
7 March 2014
New nitrile demand to be matched by supply. With new glove demand being
skewed towards nitrile gloves, most glove makers have responded by bumping up
their nitrile production capacity. Based on nitrile capacity expansion plans, we
estimate that the new nitrile supply from glove makers will amount to 14.1bn pieces
for FY14. This will be soaked up by new global demand of an estimated 13.8bn
pieces this year. Assuming a 20% y-o-y growth for nitrile gloves up to 2016, we
reckon that there would be no oversupply as the upcoming nitrile capacity will be
consistently taken up by growing global demand for such gloves, as shown in the
chart below.
Figure 4: New nitrile capacity vs new global demand
(bn pieces )
18.0
16.0
14.1
14.0
12.0
13.8
14.6
14.8
15.4
14.4
12.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
2013
2014
New nitrile capacity
2015
2016
New demand
Source: Various company data
Concerns of industry overcapacity are exaggerated. While we believe that there
will not be overcapacity in the nitrile glove segment over the next few years, we are
concerned about the impact of Hartalega’s declining ASPs owing to intense
competition and a price war in the industry (see Figure 5). We anticipate that
Hartalega could potentially be affected as its EBITDA margins are the currently the
highest in the sector. Most of the other glove manufacturers fetch EBITDA margins
ranging from 10-15% (see Figure 6), Hartalega’s lead in nitrile technology and
innovation has allowed it to enjoy margins that are twice as high. Although the group
has alleviated the pressure on margins by improving efficiency at its production lines
and developing nitrile gloves of superior quality, we believe that this will enable
Hartalega to maintain its margin premium over its peers, although competition will
see some erosion in their absolute margins.
Figure 5: Hartalega's nitrile glove ASPs
(RM/'000 pcs )
125
120
115
110
105
100
95
90
Source: Various company data
See important disclosures at the end of this report
4
Hartalega (HART MK)
7 March 2014
Figure 6: Hartalega's EBITDA vs Supermax, Top Glove and Kossan’s
EBITDA m argins
40%
35%
30%
25%
20%
15%
10%
5%
0%
FY08
FY09
Top Glove
FY10
FY11
Hartalega
FY12
Kossan
FY13
FY14
FY15
Supermax
Source: Various company data
Risks. The key risks are: i) a spike in raw material prices, ii) depreciation in the USD,
and iii) price competition within the industry.
Maintain NEUTRAL. We continue to like Hartalega’s: i) leading position in the
thriving nitrile market, ii) highly automated production lines, and iii) continuous efforts
to improve operating efficiency. That said, we believe that margins will continue to
come under pressure in the upcoming quarters due to intensifying competition in the
nitrile glove segment, which will exert downward pressure on its ASPs. We also
believe that the timely implementation of the group’s NGC is vital for it to realise its
goal of bringing back production growth in the next few years. Our unchanged TP of
MYR7.40 is pegged to an existing 19x FY15 EPS, which is +1.5SD of the stock’s
historical 5-year trading band.
See important disclosures at the end of this report
5
Hartalega (HART MK)
7 March 2014
Financial Exhibits
Profit & Loss (MYRm)
Mar-11
Mar-12
Mar-13
Mar-14F
Mar-15F
Total turnover
735
931
1,032
1,189
1,316
Cost of sales
(462)
(634)
(683)
(830)
(920)
Gross profit
273
297
350
359
396
Gen & admin expenses
(25)
(28)
(31)
(36)
(39)
Selling expenses
(10)
(11)
(13)
(14)
(16)
(2)
(5)
(5)
(6)
Other operating costs
(7)
Operating profit
236
254
301
303
334
Operating EBITDA
261
283
333
340
375
Depreciation of fixed assets
(25)
(29)
(32)
(37)
(41)
(0)
(0)
0
Amortisation of intangible assets
Operating EBIT
236
254
301
-
-
303
334
Other recurring income
10
6
6
2
2
Interest expense
(2)
(2)
(1)
(7)
(6)
Pre-tax profit
243
258
306
298
330
Taxation
(53)
(57)
(71)
(43)
(47)
(0)
(0)
(0)
(0)
Minority interests
(0)
Profit after tax & minorities
190
201
235
256
283
Reported net profit
190
201
235
256
283
Recurring net profit
190
201
235
256
283
Mar-11
Mar-12
Mar-13
Mar-14F
Mar-15F
236
254
301
303
334
25
29
32
37
41
(41)
(44)
36
(77)
(21)
Source: Company data, RHB estimates
Cash flow (MYRm)
Operating profit
Depreciation & amortisation
Change in working capital
Other operating cash flow
Operating cash flow
Interest received
12
8
5
95
232
246
374
359
352
(3)
-
-
-
(2)
(1)
2
2
1
7
6
Tax paid
(48)
(47)
(56)
(43)
(47)
Cash flow from operations
185
200
318
323
310
Capex
(22)
(35)
(18)
(250)
(200)
Other investing cash flow
(59)
(25)
(176)
Cash flow from investing activities
(81)
(60)
(194)
(250)
(200)
Dividends paid
(57)
(87)
(99)
(115)
(127)
(2)
(15)
(12)
0
7
7
(59)
(95)
Cash at beginning of period
75
Total cash generated
45
Forex effects
(2)
1
Interest paid
Increase in debt
Other financing cash flow
Cash flow from financing activities
Implied cash at end of period
117
-
-
-
(7)
(6)
(104)
(122)
(133)
117
163
182
231
45
20
(48)
(23)
163
-
-
-
183
134
208
Source: Company data, RHB estimates
See important disclosures at the end of this report
6
Hartalega (HART MK)
7 March 2014
Financial Exhibits
Balance Sheet (MYRm)
Mar-11
Mar-12
Mar-13
Mar-14F
Mar-15F
117
163
182
231
207
65
98
87
125
138
Accounts receivable
101
117
125
150
166
Other current assets
3
0
0
0
0
286
378
394
505
510
Total cash and equivalents
Inventories
Total current assets
Total investments
0
0
1
1
1
349
380
535
651
810
Intangible assets
0
0
7
7
7
Total other assets
0
0
0
0
0
Total non-current assets
349
380
543
658
817
Total assets
1,328
Tangible fixed assets
635
758
936
1,163
Short-term debt
15
13
8
8
8
Accounts payable
57
60
93
79
88
Other current liabilities
7
12
15
15
15
Total current liabilities
79
85
115
101
110
Total long-term debt
24
12
4
104
104
Other liabilities
37
41
50
50
50
Total non-current liabilities
61
53
55
155
155
Total liabilities
140
138
170
256
265
Share capital
182
183
367
367
367
Retained earnings reserve
307
421
399
540
695
5
16
-
-
494
620
766
906
0
1
1
1
1
(0)
0
(0)
(0)
(0)
Other reserves
Shareholders' equity
Minority interests
Other equity
1,062
Total equity
495
620
767
907
1,063
Total liabilities & equity
635
758
936
1,163
1,328
Source: Company data, RHB estimates
Key Ratios (MYR)
Mar-11
Mar-12
Mar-13
Mar-14F
Mar-15F
Revenue growth (%)
28.5
26.7
10.9
15.2
10.6
Operating profit growth (%)
32.6
7.6
18.5
0.8
10.2
Net profit growth (%)
33.0
5.8
16.7
8.9
10.6
EPS growth (%)
33.0
5.8
16.7
8.9
10.6
Bv per share growth (%)
39.6
25.3
23.6
18.4
17.2
Operating margin (%)
32.1
27.2
29.1
25.5
25.4
Net profit margin (%)
25.9
21.6
22.8
21.5
21.5
Return on average assets (%)
34.2
28.9
27.7
24.4
22.7
Return on average equity (%)
44.8
36.2
33.9
30.6
28.8
(15.8)
(22.3)
(22.2)
(13.1)
(8.9)
DPS
0.11
0.09
0.15
0.16
0.18
Recurrent cash flow per share
0.25
0.28
0.44
0.45
0.43
Net debt to equity (%)
Source: Company data, RHB estimates
See important disclosures at the end of this report
7
Hartalega (HART MK)
7 March 2014
SWOT Analysis
 The world’s largest nitrile glove producer
 Price
competition in
the rubber
gloves industry
 Owns several patents for in-house propriety machines
 Highly automated production processes
 Increasing
exports to
developed
markets such
as the US and
EU
 Creates own
brand
distribution
channels in
China and India
 Overly reliant on nitrile gloves production
P/E (x) vs EPS growth
P/BV (x) vs ROAE
8.0
33%
15
20%
6.0
25%
10
13%
4.0
17%
5
7%
2.0
8%
0
0%
0.0
0%
P/E (x) (lhs)
EPS growth (rhs)
Source: Company data, RHB estimates
P/B (x) (lhs)
Jan-15
27%
Jan-14
20
Jan-13
42%
Jan-12
10.0
Jan-11
33%
Jan-15
25
Jan-14
50%
Jan-13
12.0
Jan-12
40%
Jan-11
30
Return on average equity (rhs)
Source: Company data, RHB estimates
Company Profile
Hartalega Holdings Bhd manufactures a wide range of latex gloves and is the world’s largest nitrile glove producer.
See important disclosures at the end of this report
8
Hartalega (HART MK)
7 March 2014
Recommendation Chart
Price Close
7.40
7.95
8.04
7.95
6.26
6.26
5.07
4.47
4.38
7.37
5.07
5.07
7.19
7.12
6.10
6.19
6.14
6.06
7
5.64
9.29
6.19
7.36
8.89
Recommendations & Target Price
7.93
8
NR
9
6
5
4
3
2
1
Buy
0
Mar-09
Neutral
Jun-10
Sell
Trading Buy
Sep-11
Take Profit
Not Rated
Dec-12
Source: RHB estimates, Bloomberg
Date
Recommendation
2014-02-12
Neutral
Target Price Price
7.40
7.05
2013-11-13
Neutral
7.95
7.54
2013-09-10
Buy
7.95
7.04
2013-08-07
Buy
8.04
6.85
2013-06-13
Neutral
6.26
6.32
2013-05-08
Buy
6.26
5.56
2012-11-07
NEUTRAL
5.07
5.01
2012-09-10
NEUTRAL
4.47
4.46
2012-08-16
NEUTRAL
4.47
4.51
2012-08-08
NEUTRAL
4.38
4.50
Source : RHB estimates, Bloomberg
See important disclosures at the end of this report
9
RHB Guide to Investment Ratings
Buy: Share price may exceed 10% over the next 12 months
Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain
Neutral: Share price may fall within the range of +/- 10% over the next 12 months
Take Profit: Target price has been attained. Look to accumulate at lower levels
Sell: Share price may fall by more than 10% over the next 12 months
Not Rated: Stock is not within regular research coverage
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