This article first appeared in The Edge Financial Daily on December 21, 2017

Glove sector 
Maintain neutral rating: The sector’s prospects are bright, underpinned by the expanding healthcare sector globally, both public and private, as well as the rising hygiene standards across the industries that drive the demand for gloves over the long term. The Malaysian Rubber Glove Manufacturers Association projects the global glove demand to grow by 8%-10% per annum in the coming years. Over the immediate term, Malaysian glove makers will also continue to benefit from the glove supply shortage in China, following the massive shutdown of vinyl glove factories in China recently due to environmental issues (the phasing out of the highly polluting coal-fired boilers). 

However, we are mindful of a potential supply glut at some point, with most players having embarked on aggressive capacity expansion in recent years. This could end in severe price undercutting that would hurt margins. We estimate that the combined production capacity of the Big Three (Top Glove, Hartalega & Kossan) will expand by a whopping 17% to 121 billion pieces annually in 2018, versus a 7.5% growth in 2017. Also, with input costs denominated largely in ringgit while export sales in US dollars, glove makers stand to lose from a strengthening ringgit (a reversal from the windfall they enjoyed due to the weakening ringgit in recent years). 

Glove makers generally have been able to pass on the higher or lower production cost to their customers in the past, subject only to a time lag. We expect latex prices to remain soft in 2018 as the growth in natural rubber production globally continues to outpace demand. According to the Association of Natural Rubber Producing Countries, during the first 10 months of 2017 global natural production grew by 5% year-on-year (y-o-y) to 10.4 million tonnes, while world demand for natural rubber only inched up by 1.1% y-o-y to 10.7 million tonnes. Similarly, as nitrile prices track closely that of latex, we expect nitrile prices to stay soft in 2018 as well. Latex and nitrile typically account for 45%-55% of total glove production cost. 

However, we expect higher costs in 2018 for gas (based on the RM1.50/mmBtu hike semi-annually under the gas subsidy rationalisation scheme, and assuming no rebate under the gas cost pass through mechanism), chemicals (in tandem with higher crude oil prices) and labour (potentially another hike in the minimum wage, the increase in foreign worker levy from RM1,200 to RM1,850 and the new rule mandating employers to absorb the levy). Gas, chemicals and labour constitute about 8%-9%, 6%-9% and 10%-15% of total glove production cost respectively. 

We may upgrade our “neutral” stance to “overweight” should there be any pandemic disease outbreaks which cause an upsurge in glove demand; and supply constraints for substitutes of latex and nitrile gloves, resulting in a switch to latex and nitrile gloves. Conversely, we may downgrade to “underweight” in the event of a supply glut, triggering a price war that crimps margins, and if glove makers are unable to pass on rising costs. 

Our top pick for the sector is Kossan (fair value: RM7.51). We like Kossan for its strength in research and development which translates into product innovation, investments in automation which boost efficiency, a reliance cut on foreign labour, and earnings buffer from a non-glove business, that is technical rubber products. — AmInvestment Bank, Dec 20