Hartalega (HARTA MK)

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Hartalega (HART MK - US$1.7 billion) is one of the world’s leading producers of disposable gloves for healthcare use.

The rubber glove sector enjoyed an incredible boom during COVID-19. But following the pandemic, demand has weakened, and the industry is now experiencing excess supply and widespread losses. With Hartalega’s share price down 60% from its pre-COVID levels, investors are asking themselves whether the business might be permanently impaired.

Hartalega is certainly a leader in the industry. Founder and Executive Chairman Kuan Kam Hon is a legend in the industry. The company enjoyed 20-30% returns on equity throughout most of the 2010s. And it’s been at the forefront of innovation in terms of materials technology and automation. Its latest production lines can produce 48,000 pieces per hour, far above the industry standard.

The underlying demand for disposable gloves has risen by about 9% per year pre-COVID. This growth is driven by low penetration rates in emerging markets, whose per capita consumption for gloves remains only ~5% of that in North America and Europe.

Hartalega’s growth has been further boosted by nitrile gloves taking market share from their latex equivalents. Nitrile gloves are stronger, less likely to be punctured and can withstand a broader range of hazardous materials. They’re also suitable for those with latex allergies.

In the past decade, Hartalega increased its production capacity by a compound annual growth rate of 16%. And before COVID-19, Hartalega’s annual earnings growth was around 17%.

This takes us to the impact of COVID-19. Demand has dropped significantly as inventories piled up at customers. Several glove makers, such as China’s Intco, expanded capacity rapidly. And while glove prices rose from US$23 per 1,000 pieces to US$80 in the second quarter of 2021, they’re back to US$20 today. Every single glove maker is losing money right now.

There are a few positive signs, however. Several companies have mentioned that customer inventory is being drawn down. Both Top Glove and Hartalega have raised prices somewhat, though we don’t know exactly what impact this had on their volumes.

And there’s a question of whether we’ll see a drop-off in demand now that China’s zero-COVID policy is finally over. The real turn of the cycle may take a few more quarters.

Whatever happens, Hartalega will have a better chance of surviving than almost any of its peers. Its operating profit per 1,000 gloves has been much higher than that of either Top Glove, Kossan Rubber or Supermax. While Hartalega made a small loss in the latest quarter, the numbers were small. Hartalega also has a large net cash pile of 24% of its market cap.

Once industry supply & demand improves, Hartalega’s capacity expansion will likely continue. The company has plans to build its new so-called “NGC 1.5” complex with another four production lines. These will increase the aggregate production capacity from 44 billion pieces per year to 63 billion.

I believe that Hartalega will end up at a P/E ratio of around 10.8x by 2027, with a dividend yield of 5.6%. While that may not sound particularly low, remember that Hartalega is a well-managed growth company. Historically, the stock has traded at a P/E of 22x. And if you adjust for the cash, the P/E ratio will become even lower.

The main risk is that Hartelga’s competitors expand without regard for profits. The cash accumulated during COVID-19 may be invested in new capacity, hurting industry economics.

But quarterly data suggests that industry capex has gone down to pre-COVID levels. With underlying industry growth of around 9% per year, I think it’s only a matter of time before supply & demand become balanced again.

I also don’t think that the Chinese producers hold material competitive advantages. Their margins have traditionally been low. They are subject to 10% import tariffs for gloves exported to the United States. Despite the recent minimum wage hike, labour costs remain higher in China than for imported labour into Malaysia.

With the rubber glove boom gone bust, it’s hard to say exactly when glove ASPs will bottom. I would imagine it’s going to be a drawn-out process. Then again, it’s rare for growth companies in Asia to trade close to 1x book.