KLSE: HARTA (5168)
Is the market pricing it correctly?
Author:
Leen Jason
23/1/2022
Introduction
Hartalega is a glove manufacturing company specialising in nitrile gloves. In recent years, the stock price has gone up to a high of RM20 in July 2020 and it has gone back down to a price of RM5.75 in January 2022. This is because of the COVID pandemic that drove the demand for glove products in the healthcare sector and it was overvalued due to classic greed by the market and overly optimistic analysts. The combination of tailwinds for the industry and overly optimistic expectations created a huge euphoria and bull-run for all glove stocks called “glove mania.” Is the stock market pricing the company correctly after a rough 70% drop?
Ever since its IPO of RM0.15 per share, it has accumulated roughly 38x its market capitalization and is currently sitting at a valuation of RM19.71 billion.
History
Kuan Kam Onn, who is currently the executive chairman, established Kuan Kam Hartalega in 1988 by Kuan Kam Onn. He started off with just 5 production lines in Kepong, with an annual capacity of 307 million pieces of gloves. Currently, after 34 years, it has the capacity to produce 44 billion pairs of gloves annually. That is a growth rate of roughly 15% CAGR in production capacity.
The company also changed their focus to nitrile gloves in the 2000s, as they foresaw the rise of nitrile glove demand overtaking latex gloves. This is due to developed nations changing their usage slowly to more nitrile gloves as they are more chemically durable and eliminate the risk of latex-allergy, which has become quite a problem during the 1990s when combating HIV. To put it in layman’s terms, the more you use latex, the more likely you will develop an allergic reaction to it. Hence, countries are switching to nitrile gloves to prevent latex allergic reactions before they get uncontrollable. 97% of their sales come from nitrile gloves currently.
Hartalega has always invested in R & D for new gloves like their specialty gloves and has made nitrile gloves comparable to traditional latex gloves in their properties with the additional benefit of reducing allergies. They also emphasised efficiency and always invested in new technology to enhance their production speed and not just expand with more land, but do more with less space to scale up faster in the future.
Overview of Business Model
They have a fairly simple business model. Hartalega is a glove manufacturing company. Basically, I buy raw materials, produce them, and sell them. They are mainly used for OEM glove manufacturing. OEM means that they focus mainly on manufacturing, whereas OBM means that they have their own brand. Hence, OBM tends to have a higher gross profit margin if done well. An assumption to be made is that they plan to focus on OEM because they don’t have the need to go into OBM yet as they can still expand manufacturing by increasing capacity through automation or new factories. To grow the OBM side, you need more resources to be deployed into building your own brand initially and only reap the benefits when you have a good brand, which they plan to do in the future. They are preparing for it by taking advantage of the increasing demand for gloves and expanding manufacturing capacity first and only when being OEM is no longer enough. Only then will they go into OBM, but OEM currently helps them grow steadily and prepare to become OBM. They also prioritise customer relationships by having contract basis instead of spot prices and also focusing on existing customers first, which means they won’t simply jack up the prices when there is a shortage of glove supplies and give them to the highest bidder.
Qualitative Drivers
1.A developing industry with opportunities
This is taken by Top Glove’s presentation, another glove manufacturing company and a decent competitor. The graphs above showed that the highly developed nations have a high rate of glove consumption per capita compared to developing nations. This shows that developing nations still have a growing market opportunity for gloves as they slowly invest more into healthcare, it will increase the demand for gloves. Furthermore, most developing nations are in Asia and Africa, which have higher populations compared to America or Europe. I’ll let you decide what that means.
2. Increase in demand post-pandemic and higher ASP
Even after the COVID pandemic, glove demand will still remain, mainly due to increasing healthcare rules and because developing nations will need them as they are growing. To grow an economy, the citizens will play an important role, and to prolong the lives of the citizens, investing in and improving a country’s healthcare is a must. Furthermore, the usage of gloves is basically a must, and they are disposable too, so they will be needed over and over again. Gloves help to prevent the spread of germs, bacteria, and viruses and protect patients and healthcare workers. The COVID pandemic has increased awareness of the lack of healthcare infrastructure in many nations and will give them a wake-up call to pay more attention to the healthcare sector in their respective countries. Hence, gloves will be demanded even after the COVID pandemic, but their ASP (average selling price) will decrease over time, but still remain above pre-pandemic levels due to inflation of raw materials and higher demand than before. For instance, a research house, Grandview Research, projected a 14.1% CAGR for the industry’s growth from 2020 to 2027. For context, pre-pandemic levels are around 9%. Other than that, gloves will be needed in every industry for safety and hygienic purposes, for food manufacturing and other sectors that deal with chemicals.
3. Expansion of Capacity
From the founder himself, they have been expanding recently too, and have a medium-term plan of 95 billion pieces by 2027. That’s like double the current maximum capacity. Other than building more production lines, they are also focusing on automation to increase efficiency, and in the future they may reduce the required manual labour by 20%. The good thing about robots is that they can be fully operated with no breaks needed and lower costs.
Financial Analysis
Income Statement
Because the average selling price skyrocketed, the latest results in 2021 had a higher GPM.Other than that, the total operating expense margin seems to be around 6%, and the net margin had a decreasing trend pre-pandemic. However, take note that in 2020 they actually had a higher profit before tax, but they paid off deferred tax from previous years. That’s why their net margin decreased. Other than that, the growth of profit after tax also decreased from 2020 to 2019 because of the trade war between China and the US, which meant lots of their customers had already stocked up beforehand to prepare for uncertainty, resulting in less revenue growth in the first half.
Balance Sheet
We can see that they are investing in property, plant and equipment every year as it is a core revenue driver for manufacturing companies. More factories means more production capacity. Other than that, the inventory over total assets showed that their inventory being held up compared to the total assets has always generally stayed around 9%, a declining trend pre-pandemic, but recently jumped back up because of the increase in production to meet the demand and may be stocking up for the next order. This kind of showed good efficiency in inventory management.
Furthermore, cash has always generally stayed at half of the total debt base, which is total debt, and recently a huge spike in cash came in due to the COVID pandemic tailwind. They currently have enough cash to pay off all their total liabilities, and the likelihood of them defaulting is near zero. With this much cash at hand, we can expect the company to use it for expansion, innovation, and safety.
Their debt base has generally stayed around RM300 million, but they can now take on more debt if needed, since they have the cash to protect themselves and leverage more debt to expand.
Generally, total assets increased faster than liabilities, resulting in equity increases, which means shareholders’ wealth increased.
Cash Flow Statement
Operating cash flow increased every year, which shows that the business operation is actually generating cash and is growing. We can see that the invested cash flow is mainly CAPEX, which is good as it means that they are investing for future growth via automation, expansion, and innovation. The issuance of shares is coming from their ESOS package and to treat their employees well and get them aligned with the company’s interests. I even heard some rumours about their secretary being a millionaire. Other than that, dividends paid increased this year due to the good business and usually would be half of the profit after tax for the year using pre-pandemic levels.
Also take note that the dividends paid are actually more recent to reward shareholders that held on, and the data used for financial analysis was only until March 2021. However, I don’t think they will do this forever as it is mainly due to good business and will slowly resume to 50% of profit after tax.
Additional Statistics
The declining cash conversion cycle generally, 2020 increased due to the trade war, and 2021 was good because of COVID. This shows that their inventory management and efficiency of collecting and repaying are improving.
Good ROE and ROA, especially in the manufacturing industry. Having a ROE of above 15% is already very good and above 10% for ROA. What’s most impressive is that the ROIC is above 10%, which is generally very good. This means that the company is efficient with its invested capital and generates good returns even at a pre-pandemic level. It’s hard to explain everything here, but ROIC is a very powerful and underrated metric. Just to show that the long-term assets aren’t mainly funded by borrowings but by business operations.
Current, quick, and cash ratios now show that the company’s likelihood of going bankrupt is close to zero, and they have maintained their debt levels according to assets and equities fairly well.
Bonus: Additional growth statistics
You could do the free cash flow yourself. It should be increased. I didn’t include it here because I won’t be using it for valuation and I already got the gist of the growth of the company. Also, you should go back further to understand the growth of revenue, net income, and operating cash flow for a more comprehensive understanding.
The current P/E is considerably lower, especially compared to its historical P/E. This is due to the insane surge in earnings. Later, for valuation, I will try to calculate the normalised earnings for post-pandemic and use historical P/E to get a price.
Competitive Analysis
This shows that Kossan is quite similar to Hartalega, but do take note that this info is by July 2020 and many things have changed, like production amount. However, it can still be used to visualise the different business models.
We can perform some basic analysis for Top Glove, Hartalega, and Kossan to see who grew faster and who was more profitable in the previous quarters. Why not Supermax? Well, their business model is different, being an OBM, hence it isn’t fair.
The table down below uses the fiscal year 2021 to evaluate how these companies did during the COVID pandemic that gave the industry a strong tailwind.
Hartalega
Top Glove
Kossan
We can see that all glove sectors are growing quarterly and are starting to slow down as competition increases and ASP starts to normalize. We can see that Kossan and Hartalega have considerably higher margins as compared to Top Glove. Based on the graph above, I would go deeper into Kossan and Hartalega and see historically how they performed pre-pandemic to select whom to invest in for the long term.
Risks
There are, of course, a few key risks to investing in Hartalega. The main issues are high competition, production disruption, and currency.
1. Competition
Many competitions are arising in Malaysia and China. This will further reduce the ASP faster and normalise it quicker. This is because the glove industry has a fairly low barrier of entry; you just need a couple of million to start your own production line. However, they can mitigate this as they have good customer relationships and they appreciate Hartalega’s quality too, with some customers supporting them for over 20+ years. That’s also why they focus on automation and efficiency to maintain their profit margin in the long run as more competitors come in.
2. Production Interruption
If you look at Kossan, they grew from 2020-12 to 2021-03, but Hartalega didn’t. This is because there is a production interruption as they do not have enough shipping containers to ship out their gloves. Hence, you saw explosive growth in 2021-06 due to the shortage of their existing customers’ waiting since the previous quarter. Other than that, if one of their workers contracted COVID, they had to shut the entire factory down. They are also making efforts to reduce the risk of it and 90% of their workers were vaccinated back in 2021-06, which means more or less 100% by now. The Green Barrier Strategy is basically better management to sanitize, higher screening security, and time management for the workers to reduce infection risk.
3. Currency Risk
Finally, we have foreign exchange risk. Since 90% of their sales are exports, if the Malaysian Ringgit strengthens, they will receive fewer profits. However, it could be an opportunity in a sense. When the Ringgit weakens, their profits will increase.
In my personal opinion, they are mitigating this quite well with some financial derivatives. They have it on their balance sheets and are trying to hedge this foreign exchange risk out. Furthermore, it always fluctuates and ranges around the same area. The exchange rate can’t change too much as it affects the entire country entirely and the government has always tried to control it within this range unless they want to change the dynamics of the country’s economy.
Management Analysis 
I will be mainly talking about these 3 people, the Kuan family. The founder has been here since the beginning until now. In 2020, he passed the CEO role to his son, Kuan Mun.
Leong. From their profile, we can see that they have related expertise in other fields, and also that their leadership has helped the company grow several folds. Hence, we can conclude that they are competent with a long track record of success.
Other than that, they have skin in the game as well. Their net worth is tied to the company’s net worth as they hold quite some shares in the company. Go through their top 30 investors list and there are quite some Kuans in there, which amounts to more than 200+ million shares, which is more than RM 1 billion tied to the company.
Other than that, rumours about how they treat their employees very well and that even the secretary is a millionaire because of the ESOS package, which not many Malaysian companies have.
Valuation
For the valuation part, I have chosen to forecast their earnings in 2027 and use historical P/E, especially pre-pandemic times, to get their fair price.
By 2027, they are projected to have 95.1 billion of production capacity. I’ve taken the lower end of their pre-pandemic level utilisation rate of 70% to 80%. Then, I multiply the pre-pandemic average selling price of 120 RM/1000 nitrile gloves to get the revenue. Even though it is quite the lower end, I took 15% as a conservative amount, as I think that as production increases, more costs might be incurred, although they may become more efficient. It is better to be safe than sorry. After that, I used the historical P/E multiple, the lower end, to find the price in 2027 and discounted it back with an FD rate of 3% as an opportunity cost, and the fair value now is RM 9.05.
Author Notes
Hey! Wow! Did you actually finish this article? I hope that you enjoyed this read and gained some insights into how the glove industry works and the different types of gloves. Many inspirations were taken from several people, like FIRL (good retail investors with interesting content) and students that did financial analysis on Hartalega. Other than that, I hope that this gives you a rough idea of my investment thesis.
Basically, there was a euphoria bull run and now it has gone back down to the levels of pre-pandemic. It triggered something in my brain and re-emphasized the theory that the market is rarely rational. The bull-run made it overvalued and is now going back to pre-pandemic price levels. However, the business has grown and is expanding, which will bring in more cash flow and profits for shareholders.
This means that the market is undervaluing the production expansion of Hartalega and the insane amount of pure cold cash that they received during COVID.
This is, of course, by no means financial advice to buy or sell, but I am just stating my opinion on it.
Furthermore, if you are a seasoned investor, I hope you will tolerate my assumptions if they are wrong and maybe even give some feedback. I’m sure you would probably already know most of the things said, but I hope you enjoyed your time.
A 20-year old student here is still learning and would give a try in the world of investment banking, but definitely would invest personally for financial freedom. They have a fairly simple business model. Hartalega is a glove manufacturing company. Basically, I buy raw materials, produce them, and sell them. They are mainly OEM for glove manufacturing. OEM means that they focus mainly on manufacturing, whereas OBM means that they have their own brand. Hence, OBM tends to have a higher gross profit margin if done well. An assumption to be made is that they plan to focus on OEM because they don’t have the need to go into OBM yet as they can still expand manufacturing by increasing capacity through automation or new factories. To grow the OBM side, you need more resources to be deployed into building your own brand initially and only reap the benefits when you have a good brand, which they plan to do in the future. They are preparing for it by taking advantage of the increasing demand for gloves and expanding manufacturing capacity first and only when being OEM is no longer enough. Only then will they go into OBM, but OEM currently helps them grow steadily and prepare to become OBM. They also prioritise customer relationships by having contract basis instead of spot prices and also focusing on existing customers first, which means they won’t simply jack up the prices when there is a shortage of glove supplies and give them to the highest bidder.This is taken by Top Glove’s presentation, another glove manufacturing company and a decent competitor. The graphs above show that highly developed nations have a high rate of glove consumption per capita compared to developing nations. This shows that developing nations still have a growing market opportunity for gloves as they slowly invest more in healthcare. This will increase the demand for gloves. Furthermore, most developing nations are in Asia and Africa, which have higher populations compared to America or Europe. I’ll let you decide what that means.From the founder himself, they have been expanding recently too, and have a medium-term plan of 95 billion pieces by 2027. That’s like double the current maximum capacity. Other than building more production lines, they are also focusing on automation to increase efficiency, and in the future they may reduce the required manual labour by 20%. The good thing about robots is that they can be fully operated with no breaks needed and lower costs.We can see that they are investing in property, plant and equipment every year as it is a core revenue driver for manufacturing companies. More factories means more production capacity. Other than that, the inventory over total assets showed that their inventory being held up compared to the total assets has always generally stayed around 9%, a declining trend pre-pandemic, but recently jumped back up because of the increase in production to meet the demand and may be stocking up for the next order. This kind of showed good efficiency in inventory management.
Furthermore, cash has always generally stayed at half of the total debt base, which is total debt, and recently a huge spike in cash came in due to the COVID pandemic tailwind. They currently have enough cash to pay off all their total liabilities, and the likelihood of them defaulting is near zero. With this much cash at hand, we can expect the company to use it for expansion, innovation, and safety.
Their debt base has generally stayed around RM300 million, but they can now take on more debt if needed, since they have the cash to protect themselves and leverage more debt to expand.
Generally, total assets increased faster than liabilities, resulting in equity increases, which means shareholders’ wealth increased.The declining cash conversion cycle generally, 2020 increased due to the trade war, and 2021 was good because of COVID. This shows that their inventory management and efficiency of collecting and repaying are improving. The declining cash conversion cycle generally, 2020 increased due to the trade war, and 2021 was good because of COVID. This shows that their inventory management and efficiency of collecting and repaying are improving. The declining cash conversion cycle generally, 2020 increased due to the trade war, and 2021 was good because of COVID. This shows that their inventory management and efficiency of collecting and repaying are improving.