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Hartalega Holdings




Raising TP to MYR4.70; maintain Reduce 

June 17, 2013 Rating Remains Target price Increased from 4.15 Closing price June 12, 2013 Potential downside

Valuations unattractive as dominant NBR segment sees keener competition
Action: Raising TP to MYR4.70; maintain Reduce We revise our TP upwards to MYR4.70 from MYR4.15, incorporating our updated raw material price assumptions, capacity estimates and exchange rate forecasts. Taking into account the new inputs, we adjust upward our FY13F/FY14F net profit by 6.4%/9.5%. While we acknowledge Hartalega’s unparalleled efficiencies, we think that valuations are lofty in light of a more crowded NBR glove market, which should see pricing power come under pressure, in our view. Catalyst: Margin downtrend likely as ASP continues to weaken We note that all major glovemakers are expanding aggressively in the nitrile (NBR) market, with additional capacity of c.15bn pcs slated to be put on-stream by the four main players alone in calendar 2013. While demand is likely to remain strong for rubber gloves, we think heightened competition will continue to prompt manufacturers to lower ASPs as customers enjoy better bargaining power. Thus we remain cautious on NBR-focused glovemakers as we believe that margins are likely to see a downward trend in the near term. Valuation: Expensive amid stiffer competition in the NBR space Hartalega shares currently trade at 19.1x FY14F EPS of 33.04sen, which is a lofty valuation in our view, amid intensifying competition and declining ROEs. We arrive at our TP of MYR4.70 by pegging its FY14F EPS of 33.04sen to a target multiple of 14.2x – the average one-year forward P/E it has traded at in the past 12 months. We do not use a long-term average as Hartalega saw a structural break in valuations back in 2012.

MYR 4.70 MYR 6.30 -25.4%

Anchor themes We expect healthy long-term demand outlook due to growing healthcare awareness and an aging population worldwide. Nonetheless, with competition set to increase in the years ahead, we see lower pricing power for glovemakers. Nomura vs consensus Our TP is 16% below consensus on expectations of lower margins moving forth and TP being pegged to a lower P/E multiple; we think the stock is expensive at current levels.
Research analysts Malaysia Health Care & Pharmaceuticals Celeste Yap - NSM +603 2027 6894 Bineet Banka - NSFSPL +91 22 4053 3784

31 Mar Currency (MYR)

FY13 Actual Old

FY14F New Old

FY15F New Old

FY16F New

Revenue (mn) Reported net profit (mn) Normalised net profit (mn) FD normalised EPS FD norm. EPS growth (%) FD normalised P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%)

1,032 235 235 31.67c 15.0 19.9 13.1 6.0 2.0 33.9

1,165 236 236 32.29c 6.5 N/A N/A N/A N/A 28.8

1,209 251 251 33.04c 4.3 19.1 12.1 5.2 2.4 29.8

1,376 254 254 34.73c 7.6 N/A N/A N/A N/A 26.1

1,351 279 279 35.47c 7.4 17.8 10.7 4.6 2.5 27.9 N/A N/A N/A N/A

1,636 322 322 39.72c 12.0 15.9 9.1 4.0 2.8 27.4 0.2

net cash net cash net cash

1.7 net cash

Source: Company data, Nomura estimates

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Key company data: See page 2 for company data and detailed price/index chart.

2 46.47c 1.7 7.9 1.2 26.8 19.Nomura | Hartalega Holdings June 17.2 2.3 3.4/3.0 6.209 -832 377 -53 324 377 -53 324 -1 FY15F 1.8 29.9 7.6 10.1 31.04c 33.8 2.5 15.8 17.4 10.9 11.1 14.0 14.8 20.65c 27.9 2.38 0.7 6.18   13 .1 2.72c 39.6 22.0 64.8 14.53c 0.145 492 -69 423 505 -82 423 -1 Source: ThomsonReuters.9 15.6 4.5 17.67c 1.7 23.0 45.0 12.0 15. dividend payout policy of more than 45% 26.0 27.7 22.0 27.1 10.10c 31.1 4.2 38.4 5.85 0.9 16.65c 27.9 14.1 14.0 Source: Thomson Reuters.8 20.7 45.4 30.8 22.3 45.7 23.83 1.0 13.1 15.0 22.1 4.6 5.9 17.4 31.8 17.04c 33.2 31.9 31.6 19.9 32.1 19. 2013 Key data on Hartalega Holdings Income statement (MYRmn)  Year-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) FD normalised P/E at price target (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (MYR) Norm EPS (MYR) Fully diluted norm EPS (MYR) Book value per share (MYR) DPS (MYR) Source: Company data.8 22.1 15.5 3.4 16.9 26.47c 35.9 30.4 21.1 11.1 5.1 32.2 36.0 30.6 2.7 27.8 17.0 5.8 14.9 45.3 11.7 19.57 0.5 31.04c 1.9 25.7 51.9 29.032 -731 301 6 307 339 -32 307 -1 FY14F 1.2 31.0 9.1 27.5 45.0 18.1 17.6 12.473.9 6. Nomura research Notes 22.0 66.5 19.7 22.5 29.72c 1. Nomura research   (%) Absolute (MYR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (MYR) 3-mth avg daily turnover (USDmn) Major shareholders (%) Hartalega Industries Sdn Bhd Budi Tenggara Sdn Bhd 1M 3M 12M 10.8 13.72c 39.16 39.0 23.12 33.2 12.3 We expect margins and returns above industry average.351 -930 421 -58 363 430 -68 363 -1 FY16F 1.6 33.1 14.9 21.3 3.15 35.47c 35.6 10.0 17.1 17.9 15.9 4.4 1.05 0.7 31.21 0.0 21. Nomura estimates Relative performance chart (one year) FY12 931 -634 297 -36 260 289 -29 260 -2 FY13 1.0 7.4 19.31 258 -57 201 0 306 -71 235 0 323 -72 251 0 361 -82 279 0 421 -99 322 0 201 201 -91 110 235 235 -91 143 251 251 -113 138 279 279 -126 153 322 322 -145 177 50.8 36.4 7.636 -1.1 5.1 19.1 11.5 17.8 1.8 0.10c 32.2 31.3 2.4 15.7 22.7 12.13 32.0 44.6 5.6 19.

8 51.87 270.8 45.0 43.3 44.9 46.Nomura | Hartalega Holdings June 17.8 33.5 38.096 13 93 15 121 8 0 50 179 1 0 379 537 FY15F 38 0 176 125 0 338 1 876 7 49 1.2 54.7 14 .489 13 129 15 157 9 0 50 216 2 0 403 868 Notes Reducing cash pile in line with high capex.9 46.4 45.42 339.48 310.63 285.7 40.082 1.8 47. long-term capacity expansion plans which should see capacity more than triple upon completion (estimated completed in FY21F) Balance sheet (MYRmn)  As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle Source: Company data. Nomura estimates FY12 163 0 117 98 0 378 0 370 0 10 758 13 60 12 85 12 0 41 138 1 0 183 437 FY13 182 0 125 87 0 394 1 486 7 49 936 8 93 15 115 4 0 50 170 1 0 367 399 FY14F 73 0 156 117 0 346 1 693 7 49 1.8 net cash net cash net cash net cash net cash net cash net cash net cash 0.7 2.42 149.2 42.043 7 49 1.9 55.2 50.5 42.9 38. expected higher earnings should move Hartalega back to net cash position by FY16F 620 758 766 936 916 1. 2013 Cashflow (MYRmn)  Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt Source: Company data.8 2.271 1.8 3.271 13 101 15 129 8 0 50 188 1 0 391 691 FY16F 19 0 212 158 0 389 1 1.2 44.2 2.01 0.096 1. Nomura estimates   FY12 289 -37 -52 200 -35 165 0 0 0 0 -25 140 -87 0 0 0 -7 -94 46 117 163 -139 FY13 339 38 -59 317 -18 299 0 0 0 0 -176 123 -99 0 0 0 -5 -104 19 163 182 -170 FY14F 377 -61 -73 244 -261 -17 0 0 0 0 0 -17 -113 0 0 0 20 -92 -110 182 73 -52 FY15F 430 -20 -83 327 -250 77 0 0 0 0 0 77 -126 12 0 0 1 -112 -35 73 38 -16 FY16F 505 -42 -100 363 -250 113 0 0 0 0 0 113 -145 12 0 0 1 -132 -18 38 19 3 Notes Significantly higher capex for large.489 4.271 1.2 36.7 42.

20 5.92 Note: Nitrile prices are grossed up to the same solid content as latex for comparison purpose. However.64 2. albeit slightly.95 2016F 6. We have previously attached a target multiple of 12.4%/9. with a small customer base of 450 names (>100 active ones). 22: Input assumptions changes Input assumptions (period average) Latex prices (MYR/kg) Old New Nitrile prices (MYR/kg) Old New MYR/USD Old New Source: Nomura estimates 2014F 6. capacity expansion is likely to be muted in FY14F.70. We arrive at our new TP of MYR4. We also understand from management that Hartalega’s long-term expansion programme – the Next Generation Integrated Glove Manufacturing Complex (NGC) – has been delayed by eight months due to some setback in getting various approvals from the relevant authorities.19 6.10 5. we change our target multiple to reflect the continuous improvement in the company’s operations and potential diversification as previously discussed. adding production capacity by nearly 30bn pcs upon completion. as new production lines from the NGC will only start coming into operations from August 2014. We expect construction of the NGC to be completed by FY20F. We expect margins to trend downwards We note that Hartalega’s ASPs have been trending south in the past few quarters. geographical region and customer base. while at the same time updating our raw material price assumptions and exchange rate forecasts.23 6. North American and European markets (>85% revenue). after its structural break in 2012.2x target one-year forward P/E.05 2015F 6. reflecting both a weaker raw material price and also lower profit margins. we were impressed by the company’s ability to constantly upgrade its products and production processes via on-going R&D efforts. on the back of the previously mentioned two factors.13 5. As highlighted in the earlier section.95 3.35 6. we are thus cautious of its earnings growth prospects in the near term as pricing power is likely to come under pressure. As a result. which is the average multiple Hartalega has traded at in the past 12 months. and thus view its intention to diversify positively. We note that Hartalega is currently highly concentrated on the NBR gloves segment (94% revenue). 2013 Raising TP to MYR4.77 per share. as per management guidance. construction of the new production facility will be sped up by building two production plants concurrently. Management acknowledges the fact that stiffer competition in the NBR market has prompted industry players to lower prices.35 6. maintain Reduce After a recent meeting with management.70 by pegging our revised FY14F EPS of 33.04sen to a higher 14.88 2. 15 . we adjust our FY14F/FY15F earnings estimates upward by 6.89 2.96 6.78 2.56 2. While such a strategy has worked well for Hartalega in the past. Taking into account Hartalega’s improved line speed and revised capacity expansion plans. in our view. Hartalega is highly concentrated in the NBR segment. which provides an intrinsic value of MYR4. and expects itself to continue dropping prices in the rest of the year. Our changes of inputs are summarised in the table below: Fig. We also learned that Hartalega is looking for ways to diversify itself in terms of product offerings. Our P/E-based TP is well supported by our 10-year DCF valuation with cashflows discounted back to June 2013. we think that the lack of diversification of its revenue source potentially posts inherent risks to the company.25 5.8x for Hartalega – 1SD above its 3-year mean.5%.Nomura | Hartalega Holdings June 17.

• Higher/lower-than-expected pass-on rates of cost inflation/savings. Nomura research Source: Bloomberg.6 Mean = 10. owing to shrinking EBIT margins and lower asset turnover. Nomura research While we believe that Hartalega deserves to trade at a premium to sector average P/E multiple. • Further weakening of NBR raw material prices.1 May 09 May 10 May 11 May 12 2 May 08 May 09 May 10 May 11 May 12 Source: Bloomberg. significant capacity expansion plans which will continue to boost capacity and earnings. a PEG ratio of 2. We further note that we expect Hartalega to see ROE decline from 36% in FY12. we opine that its current valuations are expensive – particularly given the upcoming keen competition in the NBR segment which has previously been dominated by Hartalega. 34% in FY13 down to 27% in FY16F. 23: Historical P/E band chart MYR 7 6 5 4 3 2 1 0 May 08 17x 14x 11x 8x 5x Fig.2 on our estimates suggests that current lofty valuations appear to be somewhat unjustified for its growth potentials.4 +1SD = 13. • Faster-than-expected completion of its NGC expansion plans. Risks to our view Upside risks • New. As well. 2013 Fig. 16 . or innovative product types which could push up margins. 24: Historical one-year forward P/E P/E (x) 18 16 14 12 10 8 6 4 -1SD = 7.Nomura | Hartalega Holdings June 17.

or any of its affiliates or subsidiaries.95 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our target price of MYR4. hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report. 3) faster-than-expected completion of its NGC expansion plans.57 Price date Stock rating Sector rating Disclosures 04-Jun-2013 Reduce Not rated Hartalega Holdings (HART MK) Rating and target price chart (three year history) MYR 5.77.6% and terminal growth of 2%. significant capacity expansion plans which will continue to boost capacity and earnings.04sen. 17 .. and 4) further weakening of NBR raw material prices. is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International.15 Closing price 4.2x. and may refer to one or more Nomura Group companies. Inc. Materially mentioned issuers Issuer Hartalega Holdings Ticker HART MK Price MYR 5. 2013 Appendix A-1 Analyst Certification I. Celeste Yap. discounted back to June 2013 on a WACC of 7. 2) higher/lower-than-expected pass-on rates of cost inflation/savings. Our 10-year DCF valuation.70 is pegged to a one-year forward P/E of 14. Inc. Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings. Risks that may impede the achievement of the target price Upside risks to our view include 1) new.57 (04-Jun-2013) Reduce (Sector rating: Not rated) Date 09-Jan-13 09-Jan-13 Rating Target price Reduce 4. or innovative product types which could push up margins. Nomura International plc or any other Nomura Group company. provides a fair value of MYR4.95 4.Nomura | Hartalega Holdings June 17. (2) no part of my compensation was. on FY14F EPS of 33.

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