HARTA's 1HFY25 result was temporarily hampered by forex.

However, we expect a strong showing in 2HFY25, boosted by the recently announced US tariffs on Chinese glove makers. It has received more inquiries from its US customers. Due to its better pricing power, more disciplined cost structure and continuous efforts to streamline operations, we raised our TP from RM3.25 to RM3.95 based on 2.8x FY26F BVPS, reflective of valuations commensurating with expected steady earnings upcycle (previously 2.3x). Reiterate OUTPERFORM.

HARTA's 1HFY25 net profit came in at 27% and 25% of our and consensus full-year net profit forecasts, respectively. We consider the results within our expectation in anticipation of a stronger 2H to be boosted by demand from the US.

QoQ, its 2QFY25 revenue rose 12% due to higher sales volume (+16%) which more than offset lower ASP (-3%). Its EBITDA unexpectedly dipped into a loss of RM11m compared to a profit of RM76m, no thanks to: (i) an abrupt weakening of the MYR against the USD, and (ii) higher costs associated with ramping up of new production lines in NGC 1.5 in anticipation of higher sales of which we expect to emanate from the United States. This brings 2QFY25 net profit to RM8.6m compared to RM32m (+111%), boosted by recognition of deferred tax assets arising from tax incentives related to capital expenditures. A 1st interim dividend of 0.56 sen/share was declared, within our expectation.

YoY, its 1HFY25 revenue rose 39% due to higher sales volume (+44%) which offset lower ASP (-3%). It returned to the black with a net profit of RM41m (vs. a net loss of RM25m a year ago) on a lower cost base following the retirement of certain inefficient production capacity.

The key takeaways from its analysts' briefing yesterday are as follows:

1. HARTA highlighted that the shipment delays in 2QFY25 were estimated at 450m pieces with the bulk of them already shipped out and will be booked in 3QFY25. Assuming these were recorded in 2QFY25, 1HFY25 PATAMI would have met 38% of full-year forecast.
2. The Group is optimistic that the strong growth momentum will sustain, as customers continue to replenish their depleting glove stockpiles. The group continues to see MoM uptrend in sales volume in Nov 2024 and expects customers' replenishment activity to pick up in subsequent quarters, underpinned by inventory rebuilding by distributors, indicating that demand recovery had further gained momentum. Presently, its sales volume had strengthened 20% MoM or approximately 2.5b pieces/month.
3. It is optimistic that ASPs are expected to inch up gradually, potentially by USD1.00 - USD2.00 per 1,000 pieces to USD22- USD23 per 1,000 pieces (compared to our FY25F and FY26F ASP assumption of USD21) due to the uptick in demand and mitigation against the appreciating MYR against USD. However, due to the lagged impact, ASP hikes will only be felt gradually starting from Nov-Dec 2024. For illustration purposes, ceteris paribus, assuming USD1.00 increase in ASP, our FY26F net profit is expected to rise by 50%.
4. In anticipation of the strong demand, it is expecting NGC 1.0 to hit maximum production capacity by end-Nov 2024. Consequently, it has commenced commercial operations of NGC 1.5 in Sept 2024, and has gradually ramped up production with an estimated 2b-3b pieces ready by Dec 2024. The group is targeting capacity to increase by 19% to 37b by end-2025.
5. The group expects to benefit from the recently announced US tariffs revision upwards. Following the news, it has since seen more enquiries from its US customers which have been reliant on Chinese glove makers. Recall, the United States Trade Representative (USTR) has recently unveiled tariff increases on Chinese imports which includes a higher tariff of 50% instead of the previously announced (in May 2024) imposition of 25% effective 2026, as well as 100% on China's rubber medical and surgical gloves' exports into the US beginning 2025 and 2026, respectively. For illustration purposes, a 50% tariff hike is expected to raise Chinese glove producers' ASP to USD25-USD26/1,000 pieces (we assume base case ASP at USD18/1,000 pieces) compared to Malaysian players' ASPs at USD16-21/1,000 pieces.

Valuations. Due to its better pricing power, more disciplined cost structure and its continuous efforts to streamline its operations, we raised our TP from RM3.25 to RM3.95 based on 2.8x FY26F BVPS (previously 2.3x), which is at the sector's early up-cycle phase of between 2x to 4x, i.e. the levels seen emerging from an up-cycle in 2012 and at a discount that we believe is valid due to the emergence of Chinese glove makers. At RM3.95, the stock implied PER is at 60x or +2.0 SD above its pre-Covid 5-year historical 1-year forward average. We don't consider this PER to be aggressive as if we have given full measure of benefit to management's guidance on ASP to earnings, we expect PER would be a more palatable level (at 40x), at 1.0SD above pre-Covid historical 1-year forward average for HARTALEGA. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 3). Reiterate OUTPERFORM.

Outlook. With market expectations of losses and falling ASPs increasingly being priced in, we see sector value emerging on a medium-term horizon. Amplifying the optimism are: (i) indications pointing towards strong demand recovery moving into 2HCY24 and CY25 underpinned by inventory rebuilding from distributors and faster-than-expected industry consolidation,( ii) tell-tale signs that predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competitors) have diminished as Chinese players' utilization hit >90%, and (iii) US imposition of tariff ratchets up to 50% and 100% in CY25 and CY26, respectively, (revised up as announced on 13 Sept) making Malaysian glove makers the prime beneficiary. We expect glove stock prices to re-rate in anticipation of near-term earnings upsurge which clearly is a positive for the sector. We now expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants and exit of new entrants. Based on our estimates, the demand- supply situation will only start to head towards equilibrium in CY26 when there is no more net new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum underpinned by rising hygiene awareness.

Key risks to our recommendation include: (i) certain Chinese glove giants ramp up predatory pricing practices (i.e. selling below cost over an extended period of time to eliminate competitors), (ii) weaker-than-expected growth in demand for gloves due to slower-than-anticipated hygiene standards implementation and health awareness globally, and (iii) unfavourable changes in tariffs to Malaysian glove makers.

Source: Kenanga Research - 13 Nov 2024