KUALA LUMPUR (July 1): CGS-CIMB Research downgraded the rubber glove sector to "neutral" from "overweight" due to weaker earnings prospects.

In a note yesterday, the research house said the weaker earnings prospects are forecast to occur through declining average selling prices (ASPs) and an aggressive capacity build-up.

CGS-CIMB noted that the “aggressive capacity build-up in the sector is a concern”.

In view of the surge in global glove demand born out of the Covid-19 pandemic, glove makers under its coverage are aggressively growing their production capacity, with it estimating that the collective capacity will rise by 60.5% by end-2023 from 201.2 billion currently.

“This is notwithstanding new supply from other existing glove makers and new entrants with more companies venturing into glove production. While an oversupply situation should not occur in the near term, the rise in global glove supply should lead to more balanced supply-demand dynamics in the sector,” the research house noted.

CGS-CIMB believes that ASPs of rubber gloves peaked in the first quarter of 2021 (1Q21) and should decline going forward. 

This is due to aggressive expansion plans of both new and existing glove makers, as well as slower buying patterns of customers and diminishing spot orders.

The research house expects ASPs per 1,000 pieces to reach US$77 (about RM319.92), US$39 and US$29 respectively in 2021, 2022 and 2023, adding that it is “of the view that ASPs will decline to pre-Covid 19 levels” (US$21 to US$24 per 1,000 pieces) given the higher production costs and higher consumption patterns.

CGS-CIMB conducted proprietary case studies of the dynamics of global glove supply and demand, and its findings indicated that “a glove supply surplus is unlikely to happen in the next two to three years”. However, it noted that the pace of incoming supply of gloves may be ahead of global demand growth from CY24 (calendar year 2024) onwards in the event that sector capacity growth continues at above 20% per annum, global glove demand grows below 10% per annum and the top seven listed glove makers’ market share of the global glove supply is at 60% or below annually.

“While we turn 'neutral' on the sector’s prospects, current valuations have accounted for the weaker earnings prospects in our view.

"This is supported by: i) solid dividend yields (3.3% to 13.2% forecast for CY21 to CY23); ii) strong balance sheets (with all glove makers at net cash positions); and iii) Malaysia’s dominant position in global glove exports (67% market share in 2020). We also believe in ESG (environmental, social and corporate governance) metrics of the glove makers, mainly in regard to social compliance,” the research house pointed out.

Its top sector pick is Kossan Rubber Industries Bhd, while also maintaining its “add” call on Hartalega Holdings Bhd. This, CGS-CIMB said, is due to their attractive valuations (at a steep discount to the five-year [2015-2019] mean and 10-year mean), the lesser extent of volatility in earnings (lower ASP hikes during Covid-19) and less exposure to spot orders.

It downgraded Supermax Corp Bhd to "hold", from "add" previously, as its expects the glove maker's ASPs in the financial year ending June 30, 2022 (FY22) to FY24 to fall by a larger quantum vis-a-vis its meets as its original brand manufacturing (OBM) model will not provide better margins in a normalised environment. 

Upside risks to the sector include a sharp rise in glove demand and/or ASPs, while downside risks include a sharper-than-expected fall in glove ASPs.