HARTA expects to benefit from the recently announced US tariffs on Chinese glove makers. It has seen more enquiries from its US customers. Indications are pointing to a strong demand recovery moving into FY26 that appears to exceed our previous assumptions. We keep our FY25F earnings unchanged as we assumed a lower margin due to forex and offset by higher utilisation rate. However, we raise our FY26F net profit by 12%, and our TP to RM3.25 (previously RM3.20). Reiterate our OUTPERFORM call.

We are positive on the prospect of HARTA. The key takeaways from a luncheon meeting yesterday are as follows:

1. 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 Sept 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%-30% MoM or approximately 2.3b-2.5b pieces/month. This lifted utilisation rate, which was 78% in 1QFY25, to 88%-95% vs. our assumption of 78%/90% for FY25F/FY26F.
2. In anticipation of the strong demand, it is expecting NGC 1.0 to hit maximum production capacity by end-Nov CY24. Consequently, it has commenced commercial operations of NGC 1.5 in Sept CY24 and has gradually ramped up production with an estimated 2b-3b pieces ready by Dec CY24. The group is targeting capacity to increase by 19% to 37b by end CY25.
3. The group expects to benefit from the recently announced US tariffs revision upward. 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 CY24) imposition of 25% effective CY26, as well as 100% on China's rubber medical and surgical gloves' exports into the US beginning CY25 and CY26, 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.
4. It is optimistic that ASPs are expected to inch up gradually, potentially by USD1.00 - USD2.00 per 1,000 pieces to USD22- USD23/100 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 increases will only be felt gradually starting from Nov-Dec CY24. We believe predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competition) have diminished as Chinese players' utilization hit >90%.
5. We are not perturbed by the present appreciation of MYR against the USD as we expect the rising momentum of sales volume will more than offset the impact from the stronger MYR. YTD CY24, the USD had weakened 10% against the MYR (USD1 = MYR4.28). Ceteris paribus, (i) a 1% strengthening of MYR against USD will lead to an average 1.5% decrease in the net profit of rubber glove players, and (ii) a 1% rise in sales volume is expected to add 1%-2% to net profit. Note that since nitrile raw material (30%-40% of total cost) prices are quoted in USD, this gives manufacturers a slight natural hedge as ASPs are also quoted in USD.

Valuations. We raise our FY26F net profit by 12% as a result of raising our utlisation rate from 90% to 97%. We also raised our FY25F utilisation rate assumption from 78% to 88% but assumed a lower margins as we expect 2QFY25 earnings drag from forex due to appreciation of MYR vs USD and keep our FY25F earnings unchanged. Consequently, we raised our TP from RM3.20 to RM3.25 based on unchanged 2.3x FY26F BVPS, which is at a discount to sector's recovery cycle of between 1.8x to 2.5x, i.e. the levels seen emerging from an oversupply downturn in 2008, and a discount that we believe is valid due to the emergence of Chinese glove makers. 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 being derived on a medium-term horizon. Amplifying the optimism are: (i) indications pointing towards a strong demand recovery moving into 2HCY24 and CY25 that will be stronger than what we had previously assumed, 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 end predatory pricing practices (i.e. selling below cost over an extended period of time to eliminate competitors), leading to a strong earnings rebound for the sector, (ii) strongerthan-expected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (iii) further changes in tariffs which have happened before; recall that post the implementation of the initial 15% tariff on Chinese glove imports, this figure was lowered to 7.5% during phase first US-China trade agreement back in 2019, and (iv) epidemic and pandemic occurrence

Source: Kenanga Research - 10 Oct 2024