Tuesday 19 Mar 2024
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This article first appeared in The Edge Malaysia Weekly on June 12, 2017 - June 18, 2017

AFTER a lacklustre 2016, glovemakers have made a stunning comeback over the past month.

Falling latex prices, down almost 30% from a record high of RM8.18 per kg last year, have been a catalyst for the rally. But more importantly, competition has moderated as capacity expansion decelerates.

Glovemakers are expected to boast better margins going forward, fully capitalising on the falling raw material costs.

Even the gradual strengthening of the ringgit against the US dollar has not restrained the bullish sentiment in the sector.

The big four glovemakers — Hartalega Holdings Bhd, Top Glove Corp Bhd, Kossan Rubber Industry Bhd and Supermax Corp Bhd — are, however, not created equal.

Hartalega has been the runaway beneficiary, up 43% year to date to a record high of RM6.86 per share. From one year ago, this marks a gain of more than 80%. It is also 15% higher than the peak of the last rally that ended early last year.

In fact, Hartalega has surpassed even the most bullish of analyst forecasts, now valued at over 40 times earnings based on last Thursday’s closing price of RM7 per share.

The question is, will Hartalega’s earnings be able to support its position as the most expensive glove stock?

For the fourth financial quarter ended March 31, 2017 (4QFY2017), Hartalega’s revenue jumped 31.6% year on year to RM526.997 million; a record high. At the same time, net profit rebounded sharply by 45.3% y-o-y to RM89.4 million.

While the growth is impressive, it is important to note that it comes off a low base. Nonetheless, investors will be glad to see the glovemaker’s net margins recover to 17% in the quarter.

This gives Hartalega the highest margins among the big four, riding on the group’s purportedly high efficiency. That said, margins today are still well below the rich margins of more than 22% the group enjoyed three to four years ago.

 

Competition easing

Despite a strengthening ringgit, which should hurt exporters, glovemakers have seen total revenue climb this year by 26.3% y-o-y.

It is interesting to note that net profit in the industry has not performed as well, up only 0.7% y-o-y in the same period. Only Hartalega appears to be enjoying a stronger bottom line along with the top-line growth.

“The main driver for glovemakers has been the decreased competition on a global level. This is due to a slowdown in capacity expansion by major glove players,” explains Affin Hwang Capital analyst Aaron Kee.

At the same time, he notes that a number of factories in China have been shut down as a result of the government’s initiative to manage pollution. He points out that to date Malaysia’s rubber glove export volume has surged by about 26% y-o-y as local manufacturers tighten the slack left by China’s glovemakers.

Keep in mind that global glove demand continues to grow at a steady 6% annually.

“The biggest worry about the glove industry had been the intense competition. The market was worried that supply growth would outpace demand, and margins would become compressed,” adds Kee.

As competition eases, a key benefit will be the ability of manufacturers to pass on higher raw material costs.

Over the past year, there was a surge in latex prices, hitting a high of RM8.18 per kg.

Kee points out that the key reason for the high latex prices was partly an intervention by Thailand to protect farmers from a price slump early last year. The rise in latex prices was then exacerbated by severe flooding in southern Thailand — the world’s largest rubber growing area.

In addition, there was a brief 19% y-o-y spike in China’s automotive sales in February. However, both these factors were only temporary. Automotive sales in China already slumped in March, he says, down 3% y-o-y.

“The flooding will only cause a one-off spike in latex prices. It should moderate going forward. And because competition has eased, glovemakers will actually be able to enjoy better margins,” explains Kee, who expects latex prices to moderate to between RM6 and RM6.50 per kg.

Against this backdrop, his top pick for the sector remains Top Glove with a target price of RM6.50 a share, based on a price target of 18 times FY2017 earnings.

“The risk-to-reward with Top Glove is better than its peers. Top Glove is also expanding capacity, which will allow it to capitalise on the lower-competition environment” says Kee.

In contrast to Hartalega, Top Glove is valued at only 25.3 times historical earnings based on its closing share price of RM5.74 last Thursday.

Looking ahead, all eyes will be on Top Glove’s upcoming third-quarter ended May 30 results, which will be released this Friday. Specifically, analysts will be looking to see if Top Glove’s net margins can recover to the low teens at least from the current 9.8%.

Meanwhile, expectations for Kossan and Supermax are expected to remain relatively low. This is mainly because both have not been able to ramp up production volume as aggressively as Hartalega and Top Glove.

Supermax will still need at least another six months to a year to digest its new contact lens business, which has been eroding bottom-line growth.

 

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