January 21, 2011

HARTA - Nitrile wave keeps rolling

Stock Name: HARTA
Company Name: HARTALEGA HOLDINGS BHD
Research House: MAYBANK

Hartalega Holdings Bhd
(Jan 19, RM5.38)
Upgrade to buy at RM5.44 from hold, target price RM6.80
: Hartalega is set to profit from the structural demand switch to nitrile gloves at the expense of latex gloves.

Demand for nitrile gloves will continue to encroach into the latex gloves market as nitrile gloves' average selling price (ASP) discount to latex widens (atypical in the past).

Top Glove's M&A search for nitrile glovemakers and the declining earnings from latex gloves are some of the recent developments that support our 'buy' call for Hartalega.

Nitrile gloves are now up to 30% cheaper than latex gloves, an unforeseen, atypical trend in the past. This is due to continued escalation in latex costs (+60% year-on-year) vis-''-vis synthetic rubber (a major material cost for nitrile gloves; +28% y-o-y).

The price disparity favouring nitrile demand, which is evident in the US and European markets, is set to catch up in the emerging markets (Asia, Latin America).

Hartalega has for the first time started to sell nitrile gloves to Argentina this month. Kossan will dedicate a few of its recently installed 22 lines for the Brazil nitrile market. ASP-wise, Top Glove has now quoted its nitrile gloves on par with its low-end latex powdered gloves and is considering accelerating the expansion into the nitrile gloves segment via M&A.

We expect predominant nitrile glove producers like Hartelega to continuously show stronger quarter-on-quarter results, while the reverse is expected for latex glove producers (Top Glove, for example). We expect Hartalega to deliver a 4% to 5% sequential earnings growth in 3QFY11' the results are expected to be released on Feb 7.

Our new target price offers 25% upside. We have raised our FY11/13 earnings forecasts by 8% to 10%, taking into account a higher market share gain of 0.5 percentage point per year (0.3ppt previously). At our new RM6.80 TP (+26%) post earnings upgrade and removing a 10% discount for improving prospects, Hartalega is valued at an implied 11 times CY12 price-earnings ratio (PER) against Top Glove's 13 times.

We think the valuation discount to Top Glove (with a negative outlook) should narrow. We reckon the market will re-rate Hartalega upwards when the shifting nitrile trend takes hold.

The two biggest nitrile glovemakers (Hartalega and YTY Industry Sdn Bhd) have insignificant sales to Asia and close to zero sales to South America currently. The only notable nitrile glove supplier in South America is Latexx Partners Bhd.

We think the factors constraining nitrile glovemakers selling to the emerging markets are: (i) sticky regulations in Brazil limiting Hartalega's nitrile glove exports (it is able to meet the quality required but not the thickness); (ii) nitrile glovemakers' strategies to focus sales on the highly regulated/affluent markets (US and Europe) where their lower-end peers will not be able to compete.

But this is bound to change as distributors/end-users from the emerging markets will demand more of the cheaper nitrile gloves.

Since early-2010, nitrile gloves ASP has stayed below latex powder free (PF) gloves. The discount has widened gradually to 10% to 30% currently, depending on the prices quoted by the different glovemakers.

This is due to the high latex cost which continues to chart a new high on a daily basis and is unlikely to ease owing to the approaching 'wintering season' of rubber trees (typically from February to May).

With latex cost staying at such high levels and synthetic rubber cost only climbing gradually, we believe nitrile ASP could stay below that of powder-free gloves for an extended time. ' Maybank IB Research, Jan 19


This article appeared in The Edge Financial Daily, January 21, 2011.

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