• Expect 1Q18F core profit to come in at Bt60m (-8% yoy, -13% qoq) due to weak GPM on strong baht and small tanning volume in Jan-Feb
• New plant #10 to start operation in late May, stronger than expected baht should enable IHL to negotiate prices for tanning services
• OUTPERFORM, TP Bt13; operational hiccups are part of transition process; expect stronger performance after the completion of its new plant in June 18

Strong Thai baht to crimp GPM in 1Q18F

The strong Thai baht (31.5/USD in 1Q18, +10% yoy, +4% qoq) is a major concern for exporters, including IHL as it quotes tanning services prices in USD while its costs are mostly in baht. According to USDA data, cattle hide (excluding wet blues) surged 43% qoq and 161% yoy to 356k units in 1Q18 but almost half was exported in late February (see Fig. 1). This should affect only a small tanning volume in Jan-Feb. Thus, we expect revenue from tanning services to come in at Bt165m (+51% yoy, -10% qoq), the surge yoy driven by new orders from GLI. Revenue from sale of leather car seats should grow 5% yoy to Bt400m, in line with 12% growth in Thailand’s car output in Jan-Feb. Blended GPM should edge down to 20.8% (-3.1ppt yoy, -0.5ppt qoq) given a strong baht, which comprised 20% leather car seats and 23.5% tanning services. Overall, IHL should post Bt60m core earnings (excluding forex). 1Q18F profit should account for 17% of our full year forecast. We see c.4-7% downside to FY18F profit but will review our forecast after 1Q18 results are out.

Negotiating better prices for tanning services

In a recent update, IHL gave an update on plant #10. They should complete installing the automation system soon and start operation in late May. We believe IHL should be able to negotiate better prices for tanning services they have not revised pricing since 1Q17, despite the baht appreciating 10% against the USD, this could lead to higher margins in 2H18 at late. We expect earnings to improve substantially in 2H18 supported by the above factors. However, 1H18 performance would be unexciting given the strong baht and transition effect for plant #10.

Operational hiccups are common during transition

The share price has plunged 24% MTD possibly due to expectations of unexciting 1H18 results and profit-taking after conversion of warrants to shares. However, operational hiccups should not be major concern, and we should focus performance after the completion of its new plant in June 18. Our TP is pegged to 21x FY18F PE (fully-diluted EPS) or +1.0SD of its 5-year mean multiple.