PP 7767/09/2010(025354)

Malaysia

9 September 2011

Corporate Highlights
V is it Note

RHB Research Institute Sdn Bhd A member of the RHB Banking Group
Company No: 233327 -M

MARKET DATELINE

9 September 2011 Share Price Fair Value Recom : : : RM5.61 RM6.06 Market Perform (Downgraded)

Hartalega
Expansion Plans Key To Capture Europe Market

Table 1 : Investment Statistics (HARTA; Code: 5168) Net FYE Mar 2011 2012f 2013f 2014f Turnover (RMm) 734.9 926.4 1051.4 1307.5 Profit (RMm) 194.1 218.7 253.5 313.0 EPS (sen) 53.4 60.1 69.7 86.0 Core EPS# (sen) 52.2 60.1 69.7 86.0 EPS Growth# (%) 241.7 15.2 15.9 23.5 PER# (x) 10.7 9.3 8.1 6.5 C.EPS* (sen) 58.0 65.0 85.0

Bloomberg: HART MK

Net P/NTA (x)

4.1 3.3 2.6 2.1

Gearing (%)
0.0 0.0 0.0 0.0

ROE (%)
44.7 39.2 36.3 36.1

NDY (%)
3.7 4.6 5.0 6.2

# Excludes exceptionals Main Market Listing /Non- Trustee Stock / Syariah-Approved Stock By The SC * Consensus Based On IBES Estimates

We met with management recently and set out below the key highlights from the meeting. Growth in the Europe market. Management targets FY12 revenue growth of 20-30%, driven by growing demand from markets in Europe and steady demand from the US. We believe the rapid growth in demand for nitrile gloves there is mainly due to customers shifting purchases from natural rubber gloves to nitrile gloves due to the higher volatility in latex prices (as compared to nitrile prices), leading to uncertainty and fluctuations in natural rubber glove ASPs. Production to be boosted by two additional lines in Plant 5 Given the rapid growth in demand for nitrile gloves, the company plans to add two new lines in Plant 5 in order to meet forward orders from clients. The two additional lines are expected to increase annual production capacity by 400m pieces to 10 bn pieces (from 9.6 bn pieces currently) and is slated to begin production by 1Q 2012. and capacity expansion at Plant 6. The new factory will house a total of 10 lines focusing on producing nitrile gloves with two new lines slated to begin commercial production in Jan 12 and the rest coming on stream progressively. These new lines would be the Groups most efficient lines to date with a production rate of 40,000 pcs/hour (vs. industry average of 24,000 pcs/hour). Risks. 1) Sharp surge in raw material prices which may result in margin squeeze; 2) Appreciating RM against the US$; and 3) Execution risk from capacity expansion. Forecasts. Overall, our FY12/FY13/FY14 net profit forecasts have been adjusted by -2.3%/-0.3%/+8.9% after adjusting for capacity utilisation rate, ASP assumptions, USD/MYR rate, raw material price assumptions and effective tax rate. Investment case. Following the earnings revisions above, our fair value is revised downwards to RM6.06 from RM6.10, based on unchanged target CY12 PER of 9x. Hartalegas share price performance has performed well since beginning Aug 11, up 0.9% as compared to the FBM KLCI (-5.7%) and FBM Emas (-6.6%). Consequently, the stock now offers a potential market return of 2.5%, which is broadly in line with our expected market return. As such, we have downgraded our call on the stock to Market Perform from Outperform.

Issued Capital (m shares) Market Cap (RMm) Daily Trading Vol (m shs) 52wk Price Range (RM) Major Shareholders: Hartalega Industries Budi Tenggara

363.8 2,040.9 0.3 4.04-6.08 (%) 50.6 5.0

FYE Mar EPS chg (%) Var to Cons (%)

FY12 (2.3) 3.7

FY13 (0.3) 5.6

FY14 8.9 1.2

PE Band Chart

PER = 14x PER = 12x PER = 10x

Relative Performance To FBM KLCI

Hartalega

FBM KLCI

David Chong, CFA (603) 92802179 david.chong@rhb.com.my

Please read important disclosures at the end of this report.

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9 September 2011
We met up with management recently and set out below the key highlights from the meeting.

Growth in the Europe market. Management targets FY12 revenue growth of 20-30% driven by growing demand from markets in Europe and steady demand from the US. Growth from Europe has gathered momentum, currently making up 27.6% of the groups 1QFY12 revenue, as compared to 16.7% in 1QFY11 (and 21.7% in 4QFY11). We believe the rapid growth in demand for nitrile gloves there is mainly due to customers shifting purchases from natural rubber gloves to nitrile gloves due to the higher volatility in latex prices (as compared to nitrile prices), leading to uncertainty and fluctuations in natural rubber glove ASPs. Meanwhile, we understand that the flattish demand from US was due to overstocking of gloves by customers during the 2009 H1N1 outbreak. Moving forward, while demand outlook remains bright, management expects some downward pressure on nitrile glove ASPs stemming from rising competition as increasingly, glove makers are raising production capacity for nitrile gloves. To factor in the strong demand from Europe, we have raised our FY12/FY13/FY14 capacity utilisation rate assumptions to 84%/83%/85% (vs. 80.7% p.a. previously). However, we have also lowered our FY12-14 ASPs for nitrile gloves by 7-10% to reflect the impact of rising competition. Production to be boosted by two additional lines in Plant 5 Given the rapid growth in demand for nitrile gloves, Hartalega plans to add two new lines in Plant 5 in order to meet forward orders from customers. The two additional lines are expected to increase annual production capacity by 400m pieces to 10bn pieces (from 9.6bn pieces currently) and is slated to begin production by 1Q 2012. The two new lines are expected to cost RM30m. and capacity expansion at Plant 6. The company is currently awaiting regulatory approval for the construction of Plant 6, which management believes would be granted soon. The new factory will house a total of 10 lines focusing on producing nitrile gloves with two new lines slated to begin commercial production in Jan 12 and the rest coming onstream progressively. Total capex required for this expansion plan is around RM175m, which will be spread over two years and will be funded by internally generated funds. The two addional lines in Plant 5 and expansion in Plant 6 would lift Hartalegas annual production capacity from 10bn pieces to 13.5bn pieces by end-FY14. These new lines would be the Groups most efficient lines to date with a production rate of 40,000 pcs/hour (vs. industry average of 24,000 pcs/hour). Scouting for new landbank for further expansion. The company is actively looking for new landbank for further expansion beyond FY13. According to management, the optimum size of the land should be within 50-100 acres as the company prefers to streamline all it future operations in one location as this will help to minimise cost, which would also help to boost margins ahead. While the company has yet to identify a suitable piece of land, management mentioned that they were in no rush to acquire any new landbank without first conducting a feasibility study to determine its suitability. Impact of higher nitrile prices neutralised by strong latex price. Hartalegas raw material costs have risen significantly, comprising 56% of costs of sales in 1QFY12 as compared to 50% and 46% in 4QFY11 and 1QFY11 respectively, mainly due to higher nitrile prices. Nevertheless, we think the impact of customers switching from nitrile gloves to natural rubber latex gloves has been delayed given that latex prices remain stubbornly high. Currently, the price of latex is at RM8.62/kg, up from last months low of RM8.45/kg on 12 Aug. However, given the YTD rise in nitrile prices, we have adjusted up our FY12-14 average nitrile price assumptions to US$1.852.00/kg from our earlier assumptions of US$1.50-1.70/kg. To focus on human capital and improving its processes. Moving forward, Hartalegas growth strategy would include: 1) growing organically by building new production capacity; 2) leveraging on its technical know-how; 3) expanding its nitrile glove exports to more developed nations; and 4) developing human capital as well as continuously improving its processes to enhance its competitiveness against its peers. Higher dividend payout of 45%. Management intends to increase its dividend payout to 45% for FY12 (as compared to 40% in FY11) given its strong cash balance. As such, we have increased our FY12-14 net DPS from 21 sen p.a. previously to 26-35 sen for FY12-14. This represents a net payout of 45% p.a. and a net yield of 4.66.2% for FY12-14.

Risks

Risks to our view. 1) Sharp surge in raw material prices which may result in margin squeeze; 2) Appreciating RM against the US$; and 3) Execution risk from capacity expansion.

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9 September 2011

Forecast And Assumptions

Forecasts. Apart from the above changes to our capacity utilisation rate and ASP assumptions, we have lowered our FY13-14 USD/MYR rate to RM2.80-2.90/US$ (from RM3.00 p.a. previously). These factors have led to a 1.311.2% downward revision in our FY12-14 revenue projections. However, our FY12-14 EBIT projections have been raised by 0.4-11.7% mainly after adjusting down our operating expense projections, partly offset by the increase in raw material cost assumptions. Our FY12-14 EBIT margin projections of 30.5-31.2% are slightly below 1QFY12s EBIT margin of 32.4%. Together with an upward revision in our FY12-14 effective tax rate assumptions to 22% p.a. from 20% p.a. to be in line with managements guidance, our FY12/FY13/FY14 net profit forecasts have been adjusted by -2.3%/-0.3%/+8.9%.

Valuations and Recommendation

Investment case. Following the earnings revisions above, our fair value is revised downwards to RM6.06 from RM6.10, based on unchanged target CY12 PER of 9x. Hartalegas share price performance has performed well since beginning Aug 11, up 0.9% as compared to the FBM KLCI (-5.7%) and FBM Emas (-6.6%). Consequently, the stock now offers a potential market return of 2.5%, which is broadly in line with our expected market return. As such, we have downgraded our call on the stock to Market Perform from Outperform. Fundamentally, however, we remain positive on Hartalega given its niche position as the worlds largest nitrile glove producer and its technological capabilities that are well ahead of its competitors.

Table 2: Earnings Forecasts FYE Mar (RMm) FY11a Turnover Turnover growth (%) 734.9 358.5 270.3 36.8 (25.0) 245.3 33.4 (2.5) 0.0 4.4 247.2 (53.1) (0.0)

FY12F 926.4 26.1 313.9 33.9 (30.9) 283.0 30.5 (2.4) 0.0 0.0 280.6 (61.7) (0.1)

FY13F 1,051.4 13.5 364.2 34.6 (36.6) 327.6 31.2 (2.4) 0.0 0.0 325.2 (71.5) (0.1) 253.5 253.5

FY14F 1,307.5 24.4 447.0 34.2 (43.1) 403.9 30.9 (2.4) 0.0 0.0 401.5 (88.3) (0.1) 313.0 313.0

Table 3: Forecast Assumptions FYE Mar Average capacity (bn pcs) Utilisation rate (%) Average selling price (RM per000 pcs)

FY12F

FY13F

FY14F

9.6 84.0
119.15

10.6 83.0
123.58

12.6 85.0
125.94

EBITDA EBITDA margin (%) Dep. & amort. EBIT EBIT margin (%) Net interest expense Associates Exceptionals Pretax Profit Tax Minorities

218.7 Net Profit 194.1 218.7 Core Net Profit 189.7 Source: Company data, RHBRI estimates

Chart 1: US dollar weakening against the ringgit

3.9 3.7 3.5 $ R M /U S 3.3 3.1 2.9 2.7 2.5

0 3 /0 7 /2 0 0 8

0 3 /0 9 /2 0 0 8

0 3 /1 1 /2 0 0 8

0 3 /0 1 /2 0 0 9

0 3 /0 3 /2 0 0 9

0 3 /0 5 /2 0 0 9

0 3 /0 7 /2 0 0 9

0 3 /0 9 /2 0 0 9

0 3 /1 1 /2 0 0 9

0 3 /0 1 /2 0 1 0

0 3 /0 3 /2 0 1 0

0 3 /0 5 /2 0 1 0

0 3 /0 7 /2 0 1 0

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0 3 /1 1 /2 0 1 0

0 3 /0 1 /2 0 1 1

0 3 /0 3 /2 0 1 1

0 3 /0 5 /2 0 1 1

0 3 /0 7 /2 0 1 1

Source: Bloomberg

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0 3 /0 9 /2 0 1 1

9 September 2011

IMPORTANT DISCLOSURES
This report has been prepared by RHB Research Institute Sdn Bhd (RHBRI) and is for private circulation only to clients of RHBRI and RHB Investment Bank Berhad (previously known as RHB Sakura Merchant Bankers Berhad). It is for distribution only under such circumstances as may be permitted by applicable law. The opinions and information contained herein are based on generally available data believed to be reliable and are subject to change without notice, and may differ or be contrary to opinions expressed by other business units within the RHB Group as a result of using different assumptions and criteria. This report is not to be construed as an offer, invitation or solicitation to buy or sell the securities covered herein. RHBRI does not warrant the accuracy of anything stated herein in any manner whatsoever and no reliance upon such statement by anyone shall give rise to any claim whatsoever against RHBRI. RHBRI and/or its associated persons may from time to time have an interest in the securities mentioned by this report. This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this report may not be suitable for all investors. RHBRI recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investors individual circumstances and objectives. Neither RHBRI, RHB Group nor any of its affiliates, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this report. RHBRI and the Connected Persons (the RHB Group) are engaged in securities trading, securities brokerage, banking and financing activities as well as providing investment banking and financial advisory services. In the ordinary course of its trading, brokerage, banking and financing activities, any member of the RHB Group may at any time hold positions, and may trade or otherwise effect transactions, for its own account or the accounts of customers, in debt or equity securities or loans of any company that may be involved in this transaction. Connected Persons means any holding company of RHBRI, the subsidiaries and subsidiary undertaking of such a holding company and the respective directors, officers, employees and agents of each of them. Investors should assume that the Connected Persons are seeking or will seek investment banking or other services from the companies in which the securities have been discussed/covered by RHBRI in this report or in RHBRIs previous reports. This report has been prepared by the research personnel of RHBRI. Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of the Connected Persons, including investment banking personnel. The research analysts, economists or research associates principally responsible for the preparation of this research report have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors and firm revenues. The recommendation framework for stocks and sectors are as follows : Stock Ratings Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months. Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or more over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take on higher risks. Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months. Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months. Industry/Sector Ratings Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months. Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months. Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months. RHBRI is a participant of the CMDF-Bursa Research Scheme and will receive compensation for the participation. securities, subject to the duties of confidentiality, will be made available upon request. Additional information on recommended

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