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The Enigma Supermax

I have mentioned before that I have a certain, relatively small, holding of stock in Supermax. On paper the company is one of the best picks on Bursa. It is sitting on an enormous pile of cash, part of which it plans to deploy into practically doubling its production capacity. And that is without even taking into account their expected production expansion in the United States. Why then it seems to be lagging behind its peers in terms of valuations?

Average Selling Price

The keyword average selling price (ASP) has been in everyone's mouth ever since the glove frenzy started a year ago. There are a few major misunderstandings in regards with ASPs, but the biggest one appears to be related to their movement. That ASPs are going to fall is not a matter of opinion or discussion, it is certainly going to happen within the next few months, and it is simply how economics works. There are two things that need to be considered instead:

1) How fast and by how much are ASPs going to fall?

2) Will the glove companies be able to utilize their excess profits to expand sufficiently to grab/retain market share in a significantly enlarged market space post-pandemic?

In its latest quarterly report, Supermax made a very odd remark, which was quoted broadly by media and in fact caused the price of all Malaysian glove companies to drop. What they said was:

"As more new capacity is available in the market, the global glove prices have begun to decrease. The glove prices have since dropped by between 15% to 25%. Currently, the Spot market prices are lower than the contracted prices."

I wanted to wait until some clarification was provided on that by the management of the company, because as math goes, the 15%-25% drop was practically impossible, if it really meant a drop in blended ASP (as it was interpreted by many). Unfortunately, my attempts to find the analyst presentation slides hit a snag. However, Nomura shared a detailed note on the briefing call. Below is an important excerpt from that note:

"ASPs have peaked in this quarter. Blended ASP per 1,000 pcs for Jan/Feb/Mar was USD84.6/87.65/89.2. Supermax has orders booked until the end of this year with advance payment (30%-50% of order value in some cases) collected. Its contractual orders in hand will help avoid any drastic fall in ASPs for the rest of the year as spot prices have gone below contracted prices now. Currently, only 5% of its capacity is allocated to spot orders. Apr-June quarter blended ASP is likely to be in USD80-110 range, while spot prices are already at USD70-80 range."

In other words, ASPs have not fallen, on the contrary, they have increased, and they are expected to remain relatively flat for the upcoming quarter (ending June).

Factory Closures

Another point in the Supermax quarterly report that required clarification was the following:

"The Group would have recorded an even stronger performance were it not for the temporary closure at the Meru plants to do a complete sanitisation and deep-cleansing exercise following the detection of several Covid-19 cases among the foreign workers. There was loss of production output in the month of February, 2021 at the Meru Plants when workers were put into mandatory quarantine for each batch of workers at each of the respective plants."

No numerical values were assigned to any of the notes associated with factory closures. When these closures took place in February, the company released an announcement stating that the loss of annual production is estimated to be less than 1% (see here). That would have meant 4% loss for this quarter or at RM1.94 billion revenue from sales, that should've been less than RM80 million loss. However, according to Nomura's notes, the loss has been substantially higher:

"Due to shutdown in February caused by COVID-19 cases among workers, management estimates a revenue loss of ~MYR330mn and gross profit loss of MYR249mn."

Thus, without the closure the revenue for the quarter would have been RM2.27 billion, and gross profit would have been RM1.7 billion (also excluding the RM75 million donation the the Malaysian government). That would have made for a net profit of approximately RM1.275 billion at constant profit margin when adding the RM75 million donation.

US Production Expansion

One of the most controversial topics surrounding the company has been management's determination to set up production facilities in the United States. The allocated investment amount has been set at USD550 million (RM2.27 billion at the current exchange rate), which is substantially higher than its announced capital expenditure of RM1.39 billion for the building of 5 new plants in Malaysia. US manufacturing will come at substantially higher cost, especially in terms of labor costs, so such an endeavour can only be profitable if it receives the long-term support of the local government.

According to the quarterly report, a state government has approved a "projected capital investment" of USD482 million for Capital Investment Tax Credit (CITC). The company is currently looking into a potentially better incentive program offered by another state. Based on checks, the state that has a CITC program is Florida (see here). Coincidentally, the company founder and his wife recently bought a condo in Florida (see here). According to the Enterprise Florida, Inc. website:

"The amount of the annual credit is up to five percent of the eligible capital costs generated by a qualifying project, for up to 20 years. The annual credit may not exceed a specified percentage of the annual corporate income tax liability generated by the project. If the credit is not fully used because of insufficient tax liability, the unused amounts may be used in any one year or years beginning with the 21st year and ending with the 30th year after the commencement of operations.The CITC credits are:

- One hundred percent, for a project with a cumulative capital investment of at least $100 million..."

The project of Supermax will fall into this category. Below is an example of what that would mean:

As the eligible capital investment is USD482 million (RM2 billion), 5% would be USD24.1 million (RM100 million) per year. Since the project falls in the 100% claim eligibility category, the company will be able to claim up to RM100 million in taxes per year from its US operations, for a period of 20 years.

For reference, before the pandemic, the company was paying approximately RM50 million in taxes from its operations, although just for the past quarter, the company has paid RM320 million in taxes. Unfortunately we do not know how much the expected production capacity for its US operations is going to be, so it is hard to estimate how this incentive is going to affect the company's finances in the long run. Any unclaimed credit could be used for 10 years after the end of the 20-year period however, so it is safe to assume the company will be able to utilize, within a period of 20 to 30 years, the full incentive of RM2 billion, equivalent to the entire amount of the invested capital (not discounted/amortized of course). This might require some legal restructuring of the company in order to take advantage of potentially preferential tax treatment in Florida.

Another good news from the Nomura note is that according to management, the location will come with raw material supply. This might be related to previously discussed plans of the US government to invest in the building up of a supply network for the industry on US soil (see here).

Singapore Listing

Some people have been expecting Supermax's secondary listing on the Singapore Stock Exchange (SGX) to take place. However, according to Nomura's note, the management of the company has decided to postpone the exercise. Instead, the treasury shares may be distributed as bonus, and the company may consider additional share buybacks. Currently Supermax has 102,980,727 treasury shares, which represents approximately 4% of its issued shares. In my view this is good news, although my personal preference would be for cancelation of the treasury shares.

Personal Thoughts

Ideally the company would have guided more accurately on the impact of the factory closures and subsequent workforce quarantining. Additionally, extra details on the US expansion would be appreciated in order to be able to better analyze the positives and negatives of that move. For instance, I previously speculated that Supermax might be looking into securing a contract with the US federal government in order to ensure preferential treatment as a direct supplier. Last but not least, the notes on selling prices in the quarterly report were vague and were unfortunately (but as expected) misinterpreted. It would be appreciated if management provides more detailed clarity on matters of such import in the future.

Although there is much to be asked for in terms of investor relations and information disclosure, I remain upbeat on the company's prospects, especially at its present valuation. More information and clarity would certainly help improve the valuation situation quicker than anything else.

Important disclaimer: Any views expressed are for informational and discussion purposes only. None of this information is intended as, and must not be understood as, a source of advice. It is imperative that you always do your own research and that you make any decisions based on your personal situation and your own personal understanding.


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