Rubber Gloves - Positive Indicators Ahead

We maintain our OVERWEIGHT rating on the rubber gloves sector. The stage is set for a solid 2H17 following three quarters of anemic quarterly earnings growth. Post wintering months lasting between Dec till April, input latex cost has trended downwards and hence, we expect re-stocking activities to pick up again. Moving into 2H17, we expect earnings growth to be supported by new capacity expansion, re-stocking activities and conducive operating environment of stable raw material prices and the absence of price competition. Our investment case is based on: (i) analysis that the new capacity expansion is slower than expected, which should help maintain the supply-demand equilibrium, (ii) earnings growth underpinned by new capacity expansions matched and fueled by pent-up demand for rubber gloves, especially nitrile gloves, and (iii) sustained weakness of Ringgit (RM) vs. US dollar (USD). Our TOP PICK is TOPGLOV with an OUTPERFORM rating. Target Price is RM6.10 based on 20x FY18E EPS. The PER valuation of Top Glove (18.6x FY18E PER) has lagged behind Hartalega (27.4x CY18E PER). The valuation gap should narrow when we consider that Top Glove has higher levels of total capacity and similar net profit compared to Hartalega.

Mixed set of 1QCY17 results. Results of the glove makers under our coverage from the recently concluded 1QCY17 results season were largely within expectations except for Top Glove and Supermax Corporation. Hartalega stood out in terms of higher ASPs and margin improvement after getting hit by intense price competition in the nitrile segment resulting in lower margins over the past few quarters. Supermax was hit by higher raw material prices, pre-operating costs incurred on new start-ups overseas as well as advertising & promotional costs in launching new contact lens products overseas. Kossan’s margin was marginally lower due to the plant revamp and maintenance work but is expected to recover in subsequent quarters. Overall, QoQ sales volume grew for both Hartalega (+14%) and Kossan (+5%) except for Top Glove, which recorded a lower sales volume (-5% QoQ).

Volume sales to pick up in upcoming quarters. Volume sales to pick up in upcoming quarters. We expect volume sales to pick up over the next few quarters underpinned by new capacity expansion and restocking activities following the lower raw material price. The lower-than-expected sequential volume sales growth could have been due to higher input latex cost and slower-than-expected new capacity expansion. The slower-than-expected ramp-up in new capacity, which we highlighted few quarters ago, is expected to gradually come on stream in 2H 2017 and therefore, underpin forward sequential earnings growth. Recall, we have over the past three quarters highlighted that potential oversupply concerns appear to be overplayed considering that capacity expansion plans of the four rubber gloves companies under our coverage are expected to be delayed and staggered. Moving into 2H 2017, Top Glove and Kossan’s new plants are expected to be ready by early 2H 2017. In anticipation of higher demand, we expect Hartalega’s Plant 3 order capacity to be fully taken up.

Natural latex price to taper off post wintering months but expected to remain high. We expect volume sales to surge following the lower average input latex cost. Latex price appears to be trending upwards during the seasonal wintering months starting end-Dec till May. In anticipation of shortage in latex production supply during the wintering months, latex price has risen to as high as RM8.18/kg in 2017. Latex price has since tapered off from its peak of RM8.18/kg to presently RM5.67/kg. Based on industry checks, natural latex price is expected to hover between RM5.50/kg and RM7.00/kg.

R&D vital for rubber glove players over the longer term. We believe going forward, players need to intensify and leverage on research & development (R&D) in an effort to sustain or raise ASPs to fend off price competition. Players, including Kossan and Hartalega, have continuously innovated and intensified their R&D efforts. Case in point; Kossan is emphasizing on its patented accelerator-free nitrile glove and other unique types of glove. Hartalega has been producing thinner and lighter nitrile gloves from 4.7g in 2005 to 3.7g in 2007 and currently, 3.2g. We wouldn’t be surprised if Hartalega continues to innovate in terms of production processes and as well as introducing new higher value products.

Our TOP PICK is Top Glove. We like Top Glove because; (i) the PER valuation of Top Glove (18.6x FY18E PER) has lagged behind Hartalega (27.5x CY18E PER). The valuation gap should narrow when we consider that Top Glove has higher levels of total capacity and similar net profit compared to Hartalega, and (ii) the lower raw material input cost is pointing towards margins expansion in subsequent quarters due to its sheer capacity size.

Source: Kenanga Research - 5 Jul 2017