Version 8 Bloomberg: HART MK Reuters: HTHB.KL Refer to important disclosures at the end of this report Malaysia Equity Research 13 Mar 2017 HOLD La st Traded Price ( 10 Mar 2017): RM4.80 (KLCI : 1,717.58) Price Target -mth: RM5.30 (10% upside) (Prev RM5.05) Shariah Compliant: Yes Potential catalyst: Higher than expected demand for gloves Where we differ: Our forecasts are higher than consensus on higher volume assumptions Analyst Siti Ruzanna MOHD FARUK +603 2604 3965 sruzannamf@alliancedbs.com What s New Demand remains encouraging leading to ASPs offsetting increases in raw material prices Expect EBIT/k gloves to remain steady Raised FY18F/19F earnings by 6%/9% Maintain HOLD with a higher TP of RM5.30 Price Relative 6.7 6.2 5.7 5.2 4.7 4.2 3.7 3.2 2.7 RM 2.2 88 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 (LHS) Relative KLCI (RHS) Relative Index Forecasts and Valuation F Y Mar (RM m) 2016A 2017F 2018F 2019F Revenue 1,498 1,781 2,290 2,686 EBITDA 382 422 508 580 Pre-tax Profit 317 340 418 480 Net Profit 257 276 339 390 Net Pft (Pre Ex.) 252 276 339 390 Net Pft Gth (Pre-ex) (%) 26.5 9.3 23.0 14.9 EPS (sen) 15.7 16.8 20.7 23.8 EPS Pre Ex. (sen) 15.4 16.8 20.7 23.8 EPS Gth Pre Ex (%) 20 9 23 15 Diluted EPS (sen) 15.7 16.8 20.7 23.8 Net DPS (sen) 8.00 7.99 9.83 11.3 BV Per Share (sen) 91.5 100 1 5 PE (X) 30.6 28.5 23.2 20.2 PE Pre Ex. (X) 31.2 28.5 23.2 20.2 P/Cash Flow (X) 32.9 26.1 23.8 19.0 EV/EBITDA (X) 21.1 19.2 16.1 14.0 Net Div Yield (%) 1.7 1.7 2.0 2.4 P/Book Value (X) 5.2 4.8 4.3 3.8 Net Debt/Equity (X) 0.1 0.1 0.2 0.1 ROAE (%) 18.6 17.6 19.5 20.1 Earnings Rev (%): 0 6 9 Consensus EPS (sen): 17.2 19.5 21.8 Other Broker Recs: B: 1 S: 4 H: 15 268 248 228 208 188 168 148 8 108 Solid glove player Maintain HOLD, RM5.30 TP. We maintain our HOLD recommendation on Hartalega with a revised TP of RM5.30, based on 27x CY17F EPS. We expect Hartalega to register FY17-19F earnings CAGR of 15%, as improving demand and staggered capacity expansion offset slight margin compression from higher operating costs. We believe valuations has priced in this growth. Premier nitrile glove maker. We expect Hartalega s Next Generation Complex (NGC) to cement the group s position as the premier nitrile glove maker in the world, reinforcing its competitive advantages with better efficiency and sufficient capacity growth. Located on a 1-acre site in Sepang, Hartalega s NGC comprises six nitrile glove plants with a total of 72 production lines capable of producing 28.2bn gloves p.a. Each production line is able to churn out 45k gloves/hour, translating into a record high productivity level of 2.6 employees per million gloves per month (vs 3.9 currently, and industry average of 4.7). NGC to drive growth ahead. NGC Plants #1 and #2 were fully commissioned in March 2016 with 24 production lines. The average output per line is 45,000 pieces per hour. These new plants have lifted its total capacity to 20bn pieces p.a. Meanwhile, the group has started construction on NGC Plant #3 targeted for completion in 2H17. The construction of NGC Plant #4 is scheduled for completion by end-2018. Valuation: Expect share price to consolidate at current level. In our view, earnings growth prospects from NGC have largely been priced in. Our TP is based on 27x CY17 EPS. Key Risks to Our View: Increased competition could erode margins. Hartalega could face increased competition if other glove makers significantly ramp up capacity into the nitrile glove segment. This could reduce Hartalega s lucrative margins. At A Glance Issued Capital (m shrs) 1,642 Mkt. Cap (RMm/US$m) 7,881 / 1,770 Major Shareholders (%) Hartalega Industries 49.3 Employees Provident Fund 7.5 Budi Tenggara 3.0 Free Float (%) 30.9 3m Avg. Daily Val (US$m) 0.68 ICB Industry : Health Care / Health Care Equipment & Services Source of all data on this page: Company, AllianceDBS, Bloomberg Finance L.P Refer to important disclosures at the end of this report ed: JS/ sa: WMT
Jan- Apr- Jul- Oct- Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Company Guide WHAT S NEW Volume driving earnings Positive on earnings in upcoming quarters We are optimistic on the group s future earnings growth, which is backed by encouraging demand. We expect FY18F to be a better year as pressure on ASP ease s and capacity grows catering for the improving demand. Ca pturing market share from China The new regulation complying with the Paris Climate Agreement in Nov 2016 has led to closures of some factories in China. Some low end vinyl glove factories had to be shut down to be revamped to meet anti-pollution standards. This has resulted in a shift in demand trend from vinyl plastic gloves towards rubber gloves as lower supply has increased vinyl plastic gloves prices by over 30%. In our view, this is an opportunity for Hartalega to grab more market share from the Chinese players. Volume driven by capacity expansion The expansion in capacity caters for the encouraging demand. We expect Plant #3 to be fully commissioned by 2H17 with 4 lines up and running currently. Utilisation rates are high, hovering around 86%-88%. This may come down to 85% once Plant #3 is fully commissioned. We raised our volume growth assumption from 17%/13% in FY17F/18F to 21%/17%. Profitability holding steady as competition tapers off We understand pricing competition has subsided on healthy demand with higher raw material prices passed down to customers. Hence, we expect EBIT/k gloves to hover around RM17.60-RM18.00. We raised our ASP projections by 6%/7% for FY18F/19F with EBIT/k gloves at RM17.99/RM17.62 for FY18F/19F. Ca utious on raw material prices volatility The uptick in latex prices was largely driven by firmer demand for rubber as tax breaks introduced by the Chinese central government in 2016 (which effectively halved the 10% purchase tax on vehicles with 1.6-litre or smaller engines) spurred double-digit y-o-y vehicle sales growth in China. The Chinese government has continued the incentive but at a higher purchase tax of 7.5%. Separately, historical trends suggest that the upcoming wintering season (Mar-May) will likely keep latex prices elevated on the back of reduced supply likewise for nitrile prices, which tends to track latex prices closely. Higher nitrile and latex prices RM/kg 20.0 18.0 16.0 14.0.0 10.0 8.0 6.0 4.0 2.0 - EBIT/k gloves trending higher RM/k gloves 30.00 25.00 20.00 15.00 10.00 5.00 - Nitrile (RM) Latex (RM) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 EBIT/k gloves Raised earnings by 6%/9% for FY18F/19F We raised our FY18F/19F earnings by 6%/9% following adjustments to volume growth and ASPs. This translates into earnings growth of 23%/15% for FY18F/19F. Maintain HOLD, higher TP of RM5.30 We maintain our HOLD call with a higher TP of RM5.30 following our earnings revision. Our TP is based on 27x CY17F EPS. We expect the NGC, which will add 28.2bn gloves by end 2020, to help cement the group s position as the premier nitrile glove player in the world. We also expect ROEs to improve in FY18-19F. Page 2
Hartalega NGC timeline Capacity Phase Plant No of Lines No of Lines commissioned Commissioning Timeline (gloves pa) Phase 1 Phase 2 Phase 3 Plant 1 Plant 3 Plant 5 4.7 bn 4.7 bn 4.7bn 4 2019-2020 Jan 15-Mar 16 3Q2016-3Q2017 Plant 2 Plant 4 Plant 6 4.7 bn 4.7bn 4.7bn 2019-2020 Jan 15-Mar 16 3Q2017-3Q2018 Total 28.2 bn 72 Peer comparison CY2017/2018 P/E EPS Growth (YoY) Dividend Yield Price/ BVPS ROAE Recommend Target Price ation (RM) Current Price (RM) Market Cap (RM m) CY2017 CY2018 CY2017 CY2018 CY2017 CY2018 CY2017 CY2018 CY2017 CY2018 Hartalega HOLD 5.30 4.80 7,881 24.5x 20.9x 20% 17% 1.9% 2.3% 4.4x 3.9x 19% 20% Kossan HOLD 6.35 6.24 3,990 18.6x 16.4x 32% 8% 2.7% 3.0% 3.5x 3.0x 20% 19% Supermax HOLD 2.10 2.05 1,376 13.2x 11.2x (%) 15% 2.1% 2.5% 1.3x 1.1x 10% 11% Top Glove HOLD 4.80 5.16 6,466 18.9x 16.7x 0% 9% 2.7% 3.0% 3.3x 2.9x 18% 18% Weighted avg 20.3x 17.6x 13% 13% 2.3% 2.7% 3.6x 3.2x 19% 19% Page 3
CRITICAL DATA POINTS TO WATCH Capacity (m gloves) 31800 Earnings Drivers: NGC e xpansion to drive capacity growth. Located on a 1-acre site in Sepang, Hartalega s Next Generation Complex (NGC) comprises six nitrile glove plants with a total of 72 production lines capable of producing 28.3bn gloves p.a. Each production line is able to churn out 45k gloves/hour, translating into a record high productivity of 2.6 employees per million gloves per month (vs 3.9 currently, and industry average of 4.7). To date, Hartalega has completed two NGC plants. It has also started construction of Plant #3. All in, we expect Hartalega to grow its effective annual capacity by 16%/21%/17% in FY17/18/19F. Sa les volume to grow at 20% CAGR. We expect the group s utilisation to increase to 85% in FY17-19F. We assume that Hartalega may close its older and less efficient plants once the new NGC plants come online. Premised on this, we expect Hartalega to grow its sales volume by 21%/21%/17% in FY17/18/19F. EBIT/k gloves is a better metric to assess profitability. We assess Hartalega s profitability by looking at unit profitability (i.e. EBIT/k gloves), rather than profit margins. This is because profit margins can fluctuate even if there is no change in underlying profitability, because of its cost pass-through pricing (which has a 1-2 month lag). Under this pricing mechanism, profit margins can rise when costs are falling (i.e. same level of profits on lower ASP), and margins can drop when costs are rising (i.e. same level of profits on higher ASP). Lower EBIT/k gloves for FY17F. We project Hartalega s EBIT/k gloves to decline by 10% in FY17F due to higher operating costs, i.e. raw material and natural gas price hikes. Profitability would remain stable going forward as price competition tapers off. This would allow glove players to adjust pricing when there is higher cost and maintain margins. As such, we forecast EBIT/k gloves will improve slightly in FY18F by 1% and contract by 2% in FY19F. Primarily a nitrile gloves producer. Driven by the Hartalega NGC, we expect Hartalega s sales mix to continue to tilt towards nitrile gloves, from 95% in FY16 to 96% in FY18F. Demand for nitrile gloves is expected to outpace latex gloves in the coming years, but supply and demand dynamics will be weak relative to latex gloves, because of rising incoming supply. 27529.7 22941.4 18353.1 13764.9 9176.6 4588.3 0.0 90.0 72.0 54.0 36.0 18.0 0.0 27570.60 22056.48 16542.36 11028.24 5514. 0.00 21.4 17.1.9 8.6 4.3 0.0 27100 22400 19387 14191 Utilisation rate (%) 88.2 85 85 85 81 Output (m gloves) 27030 23035 19040 15703 516 EBIT/k gloves (RM) 21.2 19.8 17.8 18 17.6 Page 4
Balance Sheet: Ge aring up for expansion. Hartalega s NGC plants are expected to be rolled out over six years, but a significant portion of the RM2.2bn capex will be front-loaded because of the need to build common infrastructure, and the rapid speed in constructing Plants #1-4 (in FY14-17). As such, we expect Hartalega to gear up to fund the expansion. We forecast Hartalega will be in net gearing position of 0.1x in FY17F. Share Price Drivers: Supported by capacity and demand growth. We expect Hartalega s sales volume to grow at double digits, given capacity growth and demand for nitrile gloves. Although our expectations seem aggressive in percentage terms, the absolute increase in output is reasonable vis-à-vis the additional demand in global consumption. Unit profitability is influenced by the competitive environment, productivity, and macroeconomic factors (i.e. currency movements, raw material prices, etc.); the competitive environment is expected to drag unit profitability over the longer term. Key Risks: Increased competition could erode margins. Hartalega could face increased competition if other glove makers significantly ramp up into the nitrile glove segment. This could reduce Hartalega s lucrative margins. Potential challenge to sell the additional output. In view of Hartalega s aggressive expansion plan, the group could face difficulty in securing buyers for its additional output. This could pressure utilisation rates going forward. 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 Leverage & Asset Turnover (x) Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure RMm 450.0 400.0 350.0 300.0 250.0 200.0 150.0 100.0 50.0 0.0 Capital Expenditure (-) ROE (%) 20.0% 15.0% 10.0% 5.0% 0.0% 1.0 1.0 1.0 0.9 0.9 0.9 0.9 0.9 0.8 0.8 0.8 Company Background Hartalega is a niche player in nitrile gloves (94% of sales volume). Hartalega manufactures a wide range of latex gloves. The Company's products include natural rubber examination gloves, nitrile examination gloves, nitrile clean room gloves and natural rubber surgical gloves. It has the largest nitrile glove capacity among the glove makers under our coverage. (x) 38.6 33.6 28.6 23.6 Forward PE Band (x) +2sd: 32.8x +1sd: 29.1x Avg: 25.3x -1sd: 21.6x 18.6-2sd: 17.9x 13.6 Mar-13 Mar-14 Mar-15 Mar-16 (x) 6.2 5.2 4.2 3.2 2.2 PB Band (x) +2sd: 5.62x +1sd: 4.55x Avg: 3.48x -1sd: 2.41x 1.2 Mar-13 Mar-14 Mar-15 Mar-16-2sd: 1.34x Page 5
Key Assumptions F Y Mar Capacity (m gloves) 14,191 19,387 22,400 27,100 31,800 Utilisation rate (%) 88.2 81.0 85.0 85.0 85.0 Output (m gloves),516 15,703 19,040 23,035 27,030 EBIT/k gloves (RM) 21.2 19.8 17.8 18.0 17.6 Income Statement (RMm) F Y Mar Revenue 1,146 1,498 1,781 2,290 2,686 Cost of Goods Sold (805) (1,097) (1,332) (1,744) (2,057) Gross Profit 341 402 448 545 629 Other Opng (Exp)/Inc (75.8) (90.6) (109) (131) (152) Operating Profit 266 311 340 415 476 Other Non Opg (Exp)/Inc 0.0 0.0 0.0 0.0 0.0 Associates & JV Inc 0.0 0.0 0.0 0.0 0.0 Net Interest (Exp)/Inc 1.14 0.88 0.19 3.20 3.36 Exceptional Gain/(Loss) 10.2 4.94 0.0 0.0 0.0 Pre-tax Profit 277 317 340 418 480 Tax (66.7) (59.1) (63.4) (77.9) (89.5) Minority Interest (0.5) (0.3) (0.3) (0.3) (0.3) Preference Dividend 0.0 0.0 0.0 0.0 0.0 Net Profit 210 257 276 339 390 Net Profit before Except. 200 252 276 339 390 EBITDA 311 382 422 508 580 Growth Revenue Gth (%) 3.5 30.7 18.8 28.6 17.3 EBITDA Gth (%) (.1) 22.6 10.6 20.2 14.3 Opg Profit Gth (%) (14.1) 17.1 9.2 22.1 14.9 Net Profit Gth (Pre-ex) (%) (14.7) 26.5 9.3 23.0 14.9 Margins & Ratio Gross Margins (%) 29.8 26.8 25.2 23.8 23.4 Opg Profit Margin (%) 23.2 20.8 19.1 18.1 17.7 Net Profit Margin (%) 18.3 17.2 15.5 14.8 14.5 ROAE (%) 19.0 18.6 17.6 19.5 20.1 ROA (%) 16.3 15.1.6 13.1 13.6 ROCE (%) 17.1 16.1 13.6 14.4 15.1 Div Payout Ratio (%) 49.7 51.0 47.5 47.5 47.5 Net Interest Cover (x) NM NM NM NM NM Page 6
Quarterly / Interim Income Statement (RMm) F Y Mar 3Q2016 4Q2016 1Q2017 2Q2017 3Q2017 Revenue 398 400 402 437 456 Cost of Goods Sold (308) (348) (327) (349) (348) Gross Profit 90.3 52.4 74.9 87.8 108 Other Oper. (Exp)/Inc 4.90 15.4 (3.9) (4.4) (19.2) Operating Profit 95.2 67.8 71.0 83.4 88.6 Other Non Opg (Exp)/Inc 0.0 0.0 0.0 0.0 0.0 Associates & JV Inc 0.0 0.0 0.0 0.0 0.0 Net Interest (Exp)/Inc 0.0 0.15 0.19 0.07 (0.1) Exceptional Gain/(Loss) (4.0) 3.01 (3.0) 0.27 (10.1) Pre-tax Profit 91.2 71.0 68.1 83.8 78.3 Tax (18.3) (9.4) (11.7) (.6) (11.9) Minority Interest (0.1) (0.1) (0.2) 0.04 (0.2) Net Profit 72.8 61.5 56.2 71.2 66.2 Net profit bef Except. 76.8 58.5 59.2 70.9 76.4 EBITDA 113 88.9 88.1 100 106 Growth Revenue Gth (%) 4.9 0.6 0.3 8.7 4.4 EBITDA Gth (%) 31.5 (21.3) (0.9) 13.9 5.8 Opg Profit Gth (%) 37.4 (28.8) 4.7 17.5 6.2 Net Profit Gth (Pre-ex) (%) 40.0 (23.8) 1.3 19.8 7.6 Margins Gross Margins (%) 22.7 13.1 18.6 20.1 23.6 Opg Profit Margins (%) 23.9 16.9 17.7 19.1 19.4 Net Profit Margins (%) 18.3 15.4 14.0 16.3 14.5 Balance Sheet (RMm) F Y Mar Net Fixed Assets 1,044 1,402 1,571 1,700 1,819 Invts in Associates & JVs 0.0 0.0 0.0 0.0 0.0 Other LT Assets 24.8 20.5 18.2 15.8 13.5 Cash & ST Invts 70.5 84.4 302 316 338 Inventory 0 202 245 321 378 Debtors 198 239 284 365 429 Other Current Assets 0.20 14.1 14.1 14.1 14.1 T otal Assets 1,457 1,961 2,434 2,733 2,991 ST Debt 6.08 42.4 42.4 42.4 42.4 Creditor 108 147 179 234 277 Other Current Liab.6 0.82 0.82 0.82 0.82 LT Debt 0.33 206 506 556 556 Other LT Liabilities 59.5 60.8 60.8 60.8 60.8 Shareholder s Equity 1,269 1,502 1,643 1,836 2,052 Minority Interests 1.66 2.08 2.42 2.75 3.08 T otal Cap. & Liab. 1,457 1,961 2,434 2,733 2,991 Non-Cash Wkg. Capital 197 306 363 465 543 Net Cash/(Debt) 64.1 (164) (246) (282) (260) Debtors Turn (avg days) 55.3 53.2 53.6 51.8 53.9 Creditors Turn (avg days) 48.8 45.5 47.7 45.7 47.7 Inventory Turn (avg days) 52.5 57.2 65.2 62.5 65.3 Asset Turnover (x) 0.9 0.9 0.8 0.9 0.9 Current Ratio (x) 3.1 2.8 3.8 3.7 3.6 Quick Ratio (x) 2.1 1.7 2.6 2.5 2.4 Net Debt/Equity (X) CASH 0.1 0.1 0.2 0.1 Net Debt/Equity ex MI (X) CASH 0.1 0.1 0.2 0.1 Capex to Debt (%) 6,592.2 171.7 45.6 36.8 36.8 Z-Score (X) 26.2.4 8.0 7.6 7.5 Page 7
Cash Flow Statement (RMm) F Y Mar Pre-Tax Profit 277 317 340 418 480 Dep. & Amort. 45.9 70.6 82.6 93.2 104 Tax Paid (69.7) (64.7) (63.4) (77.9) (89.5) Assoc. & JV Inc/(loss) 0.0 0.0 0.0 0.0 0.0 Chg in Wkg.Cap. (47.3) (79.8) (56.7) (102) (78.7) Other Operating CF (3.5) (3.5) 0.0 0.0 0.0 Net Operating CF 202 240 302 331 415 Capital Exp.(net) (422) (426) (250) (220) (220) Other Invts.(net) 4.31 2.59 0.0 0.0 0.0 Invts in Assoc. & JV 0.0 0.0 0.0 0.0 0.0 Div from Assoc & JV 0.0 0.0 0.0 0.0 0.0 Other Investing CF 4.63 (0.1) 0.0 0.0 0.0 Net Investing CF (413) (423) (250) (220) (220) Div Paid (105) (3) (135) (147) (174) Chg in Gross Debt 1.59 243 300 50.0 0.0 Capital Issues 220 78.8 0.0 0.0 0.0 Other Financing CF (0.1) (1.3) 0.0 0.0 0.0 Net Financing CF 117 197 165 (97.0) (174) Currency Adjustments (0.8) 0.56 0.0 0.0 0.0 Chg in Cash (95.4) 13.8 218 14.4 21.4 Opg CFPS (sen) 16.1 19.5 21.9 26.4 30.1 Free CFPS (sen) (14.2) (11.4) 3.19 6.79 11.9 Target Price & Ratings History 5.06 4.86 4.66 4.46 4.26 4.06 3.86 RM 1 2 3 4 5 6 7 S.No. Date of Report Closing Price -mth T arget Price Rating 1: 04 May 16 4.10 4.10 HOLD 2: 03 Aug 16 4.08 4.20 HOLD 3: 09 Nov 16 4.74 4.60 HOLD 4: 20 Dec 16 4.75 4.60 HOLD 5: 29 Dec 16 4.76 4.60 HOLD 6: 09 Jan 17 4.73 4.60 HOLD 7: 15 Feb 17 4.78 5.05 HOLD 3.66 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Note : Share price and Target price are adjusted for corporate actions. Source: AllianceDBS Analyst: Siti Ruzanna MOHD FARUK Page 8
DISCLOSURE Stock rating definitions STRONG BUY - > 20% total return over the next 3 months, with identifiable share price catalysts within this time frame BUY - > 15% total return over the next months for small caps, >10% for large caps HOLD - -10% to +15% total return over the next months for small caps, -10% to +10% for large caps FULLY VALUED - negative total return > -10% over the next months SELL - negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date Page 9
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Additional information is, subject to the overriding issue of confidentiality, available upon request to enable an investor to make their own independent evaluation of the information contained herein. Wong Ming Tek, Executive Director Published by Allia nc e DBS Re se a rc h Sdn Bhd (8540 U) 19th Floor, Menara Multi-Purpose, Capital Square, 8 Jalan Munshi Abdullah, 50100 Kuala Lumpur, Malaysia. Tel.: +603 2604 3333 Fax: +603 2604 3921 email : general@alliancedbs.com Page 10