Hartalega Holdings Bhd (“Hartalega”) is listed in the main market of Bursa Malaysia in 2008. This company needs no introduction because everyone knows about it. Some made money from investing in it. Some made huge losses from betting on the price to increase further.
I still remember many Analyst in year 2020 made a “Buy” call with crazy target prices. Kenanga Research on 4 Oct 2020 assigned Hartalega a target price of RM26.22. Unfortunately, the company’s stock price went down instead of shooting for the moon.
At the time of writing, Hartalega is trading at PE of 4.4x which is very rare. In terms of its technical chart, it is on a downtrend. But seems like its support level is between RM5.00 to RM5.20 based on weekly chart. Then again, I could be wrong!
So, what happen to this glove company? Here’s 5 key insights you need know about Hartalega:
#1: FIRST MOVER ADVANTAGE
Hartalega is the first company that invented lightweight nitrile glove in 2005. This is a substitute to the natural rubber glove. It is a major breakthrough for the company. Nitrile glove does not contain any latex proteins. Thus, it is safe to use for those with latex allergy.
Consequently, this causes many industries switch to nitrile glove. The demand for nitrile glove further boosted when US FDA banned powdered medical gloves in 2017. According to KAF Research, most of the gloves Hartalega produced are catered for healthcare industry. Because of this, the company benefit from it financially before its rival jump into this bandwagon.
#2: UNRIVALLED ECONOMIES OF SCALE
The thing about being an OEM is that you’re competing with price. This means being able to offer the best price to customers. But you can’t always reduce your price. Companies have to make profit. The only way to do so is by reducing its costs.
For Hartalega, the management reduce its costs by being the most efficient in production. They constantly make huge investments to automate their production. According to its management, the company has the highest productivity compared to industry average. This reduces its unit cost and achieves the highest profit margin among its peers, prior to pandemic.
In 2020, the company’s profit margin seems to be lowest but actually it is not! This is because the company’s financial year end is on 31 March 2020. It has not account for the full year effect of the supply constraints. In its 2021 earnings report, the company achieves a net profit margin of 43%.
#3: STEADY INDUSTRY GROWTH
Hartalega’s main growth driver comes from the healthcare sector. This is because a big portion of its gloves are surgical gloves. If healthcare sector grows, demand for surgical glove would grow as well. Since now we’re still in pandemic, I think the growth remains high for surgical gloves.
But this demand is short-lived. I would ignore it and focus on the normalised growth rate. According to Grand View Research, global nitrile gloves market is expected to grow at 14.1% CAGR from 2020 to 2027. But the company’s management expect the growth rate to be at 8% to 10% yearly. I would think this is more realistic and certainly would incorporate into my valuation.
#4: REDUCTION IN GLOVES AVERAGE SELLING PRICE
While the glove industry is expected to grow, my biggest concern is the intense competition. There are so many new entrants recently. Not just in Malaysia but globally as well, especially, China. Couple this with increased expansion plan by existing glove players, its no wonder the glove selling price drops.
Hartalega’s management expects the price to decline further in 2H 2021 onwards. Customers are already adjusting their orders due to the decline in average selling price (ASP) of gloves. I summarised below some of the analyst comments on the future ASP for gloves:
|Frost & Sullivan||ASP is expected to decline by 59% or 52% by 2023|
|TA Securities||ASP to trend lower and normalised by end-2023 due to price war|
|Maybank IB||ASP to continue pressured by the rapidly expanding China players|
This is what causes glove stock price tumbled significantly. I think investors can only see the light in the tunnel when the ASP normalised. For now, it’s just wait-and-see approach.
#5: INCREASING DIVIDEND PAYMENT
On the bright side, this company has been paying increasing dividend since 2012. The company maintains a dividend policy of 60% payout ratio from 2018 onwards. So far it has kept its promise.
Moving forward, I would expect its dividend per share to decline in-line with the falling ASP. Nevertheless, its payout ratio will remain the same.
In a nutshell, there are few things that I don’t like about this industry. The first is its low bargain power. The ASP increase is solely because of the sudden boost in demand due to pandemic. When this is normalised, price war will be more intense. It’s like survival of the fittest. The company that is the lowest cost producer wins the game.
Another risk to take note of is the possibility of windfall tax. Our current opposition leaders have been pushing for it since last year. With the change of Prime Minister and his recent offer to working with opposition leaders, it is now very likely to happen.
Would I invest in it? There are too many uncertainties for me to decide. The major one is the intensified competition. For now, I would wait and see how big this impact will have on Hartalega.
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