(Tradeview 2020) - In Conclusion, Is the Glove Sector a "Tulip Mania" or Is Further Upside Justified?

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Following up with our earlier article "Commentaries on The Recent Glove Sector Selldown Since Top Glove Results Announcement", this time around we are studying the sector during the previous H1N1 pandemic and will try to draw some key-takeaways that could be useful for gauging the current Covid-19 situation. To ease our analysis, we only consider the earnings trend and share price performance of Top Glove, Supermax & Hartalega.

According to Wikipedia, H1N1 lasted for about 19 months, from Jan 2009 to Aug-10 while vaccine for the influenza was approved by the FDA in September 2009. During this period, we saw quarterly earnings of glove companies rising by c.2-4x to its peak and they took 5 quarters to do so (reported sometime in March-May 2010). More amazingly their share prices soared 4-10x (doubled that of profit growth), peaking in July 7 2010 (despite FDA approving the H1N1 vaccine in September 2009); hence, this goes to show that share prices are strongly correlated with quarterly profit trend.

As for Covid, this began in December 2019 and is still ongoing; no vaccine has been found and approved yet. That said, we have only witness 1 quarter of glove sector earnings performance and it was already mind blowing: 

(i) Top Glove tripled; 

(ii) Supermax doubled whilst; 

(iii) Hartalega unfortunately fell 5%. 

Based on our findings, consensus is looking at explosive earnings growth of 2-5x (at peak levels) while the most bullish analyst in town is estimating 3-9x increase. However, share prices only jumped 2-5x unlike during H1N1 where it doubled that of earnings growth; this clearly suggest that glove stocks potentially still have legs to run further. Moreover, valuations look attractive:

1. Top Glove is trading at 18x P/E vs 5-year average of 22x. When we take the EPS of the most bullish analyst, P/E is only 11x.

2. Supermax is trading at 24x P/E vs 5-year average of 14x. At glance appear demanding but if we use the EPS of the most bullish analyst, P/E drops to 16x while for the broker that estimated RM1b profit, P/E is seen to drop to only 9x.

3. Hartalega is trading at 46x P/E vs 5-year average of 32x. Again, it would fall to 28x if we use the EPS of the most bullish analyst.

Thus, we believe the recent selldown presents a good opportunity to consider accumulating; this is in spite of the concerns of windfall tax and massive capacity expansion of peers in China. 

1. Historical Valuation and Future Earnings

Firstly, we feel consensus is a little too conservative (2-5x) and should play catch up to the earnings projection of the most bullish analyst (3-9x); this is because the impact of Covid-19 is far more profound than H1N1 but consensus is forecasting only similar earnings growth profile (2-4x). Hence, assuming the windfall tax is to shave some 20% of profit projected by the most bullish analyst, P/E for Top Glove, Supermax & Hartalega is estimated to rise to 14x, 11x & 35x, respectively; when compared against historical average, valuation of Top Glove & Supermax still appear to be inexpensive.

2. The Rising Might of China

As for the massive capacity expansion by Chinese peers, it will take more than the course of 2 years. Building an automated technology driven manufacturing facility is not the same as building a makeshift hospitals in 10 days. Certifications, compliance with FDA, global audit / scrutiny / need for transparency are all prerequisite to become a global supplier of gloves. Additionally, our local glove players will also have similar plans and should be able to defend their market shares. Besides, a prolonged trade war with the US may not bode so well for Chinese players. Europe, US, Australia (G7) have taken a very protective stance against the rise of China resulting in distrust, tariff wars and propaganda attacks. Therefore, all in all, we are not overly disturbed with what they are attempting to achieve.

3.  Change in Behavioral Pattern / New Normal

We think after the Covid-19 episode, the awareness of good hygiene has increased and will further support the demand for gloves. Moreover, the % of glove cost to total healthcare expenditure is relatively insignificant. Thus, glove prices may hold better than what most people think after Covid-19. 

After considering all of the above, it is too premature to call it game over for the glove sector. Currently, there are only a handful of industries that can depict strong visible earnings growth. Furthermore, there are fears of a 2^nd wave of Covid-19. Overall, consensus has a TP of RM20.28 (most bullish analyst: RM25) for Top Glove, RM8.22 (most bullish analyst: RM11) for Supermax & RM11.58 (most bullish analyst: RM17.50) for Hartalega. For us, we would not bet against these Malaysian industrialist who managed to put Malaysia on a global limelight. Of course this is our humble view, now it is your move.

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Food for thought: 

http://www.tradeview.my/2020/06/tradeview-2020-in-conclusion-is-glove.html