Rubber Gloves - Insignificant Gas Tariff Hike, Overstretched Valuations


Gas Malaysia in an announcement to Bursa Malaysia informed that the Government has approved a natural gas tariff revision for non-power sectors in Peninsular Malaysia with effect from 1 Jan 2019 to 30 June 2019 by an average of 0.7%. Ceteris paribus, assuming a “no-cost pass through”, an average 0.7% increase in natural gas tariff is expected to only marginally impact rubber gloves players’ earnings by 0.2-0.5%. Reiterate UNDERWEIGHT due to rich PER valuations and flat sequential earnings growth. Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion as earnings growth has been pedestrian over the past eight quarters. Following a period of capacity consolidation starting back in mid-year 2016, which led to falling ASPs, glove-makers are ramping up capacities. Our analysis suggests potential oversupply is looming. We have UNDERPERFORM calls on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM4.45); and SUPERMX (UP; TP: RM2.60). Our Top Pick in the sector is KOSSAN. We like KOSSAN because it is expecting strong high-teens net profit growth in upcoming quarters underpinned by new capacity expansion from plant 16, 17, 18 and 19. TP is RM4.95 based on 25.5x FY19E EPS (+1.5 SD above 5-year historical forward mean).

Average 0.7% tariff hike for natural gas for non-power sectors. Gas Malaysia in an announcement to Bursa Malaysia informed that the Government has approved a natural gas tariff revision for non-power sectors in Peninsular Malaysia with effect from 1 Jan 2019 to 30 June 2019 by an average of 0.7%. Fuel accounts for an average of 10% of production cost, of which natural gas accounts for an average of 7% of the production cost. Ceteris paribus, assuming a “no-cost pass through”, an average 0.7% increase in natural gas tariff is expected to only marginally impact rubber gloves players’ earnings by 0.2-0.5% based on our back-of-envelope calculations. Players can easily raise their average selling prices to pass cost through. Generally, its takes approximately between one to three months to pass through the cost increase.

Estimated incoming capacity indicating potential oversupply. Following a period of capacity consolidation starting back in mid-year 2016, which led to falling ASPs, nascent signs of glove-makers ramping up capacities are emerging again. The robust demand is attracting players to ramp up production. In anticipation of higher demand and switching from vinyl gloves, players are raising capacities again. Our analysis suggests that potential oversupply is looming (please refer to our Rubber Gloves 4Q18 Strategy note). Note that previous two oversupply occurs back in year 2014 and 2016.

Shorter lead time indicating strong demand tapering off. We understand that the production of vinyl gloves in China has resumed and normalised in early 2018. Hence, we understand that over the past six months, delivery lead times (the time frame between order and delivery) has shortened from between 60 to 70 days as compared to 30 to 45 days, potentially indicating that strong demand is tapering off.



Reiterate UNDERWEIGHT. Reiterate UNDERWEIGHT due to rich PER valuations and flat sequential earnings growth. Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion as earnings growth has been pedestrian over the past eight quarters. Our analysis suggests that the strong surge in share prices of glove stocks was mainly due to changes in the PER multiple and not so much on earnings growth. Following a period of capacity consolidation starting back in mid-year 2016, which led to falling ASPs, glove-makers are ramping up capacities. Our analysis suggests potential oversupply is looming. On the flipside, key upside risk is stronger-than-expected demand. We have UNDERPERFORM calls on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM4.45); and SUPERMX (UP; TP: RM2.60).

Our Top Pick in the sector is KOSSAN. We like Kossan for : 1) its strong high teens YoY earnings growth expected in subsequent quarters underpin by new capacity expansion; 2) it is moving from good to great due to transformation in the manufacturing processes via automation, hence potential margins expansion; and 3) it is trading at an unwarranted 25% discount to peers, the valuation gap should narrow considering the solid earnings growth ahead. Our TP is RM4.95 based on 25.5x FY19E EPS (+1.5 SD above 5-year historical forward mean) due to Kossan’s strong high teens growth ahead.

Source: Kenanga Research - 27 Dec 2018

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