This article first appeared in The Edge Financial Daily on October 3, 2019
Rubber glove sector
Maintain overweight: The recent second quarter of calendar year 2019 (2QCY19) results season for glove makers under our coverage came in mixed. The star performer was Kossan Rubber Industries Bhd which recorded a 30% year-on-year growth in net profit, underpinned by new capacity expansion at plants 16, 17 and 18. Hartalega Holdings Bhd saw a small sequential growth in the first quarter of financial year 2020 ended June 30, 2019 (1QFY20), and we expect a better performance for the subsequent quarters on the back of an uptick in demand and potential margin expansion emanating from operating efficiency and better economies of scale due to increased capacity and higher sales volume. Supermax Corp Bhd’s 4QFY19 ended June 30, 2019 was hit by competition in the latex segment, an uptrend in rubber latex prices and a one-off cost which dragged down its overall bottom line. Top Glove Corp Bhd suffered a second consecutive quarterly earnings disappointment.
Due to the impact of a trade war whereby effective Sept 1, a 15% tariff has been imposed on Chinese-made medical and vinyl gloves, local rubber glove players expect to see an uptick in demand for gloves of which the positive impact is expected to be felt from the quarter ending December 2019. Theoretically, the tariff hike is expected to increase the prices of Chinese-made gloves, which could compel a switch of US glove demand to Malaysian glove players where the US accounts for between 28% and 55% of glove players’ group sales.
Looking ahead, keen competition in the latex segment could negatively impact latex glove margins. Robust demand for nitrile gloves has led to longer delivery lead times to between 45 and 50 days, compared with 30 to 40 days previously. Although we are positive on the growth in the subsequent quarters, underpinned by an uptick in nitrile demand driven by restocking activities, players like Top Glove and Supermax could continue to be plagued by competitive pressure from low-margin latex gloves (accounting for an estimated 50% of the product mix of both players), which could offset gains in the nitrile segment.
Investors should focus on nitrile-centric players. Due to intense competition in the latex segment, we recommend players that are largely nitrile-centric, including Hartalega and Kossan whose product mix hinges largely on nitrile at 95% and 75% respectively. Conversely, Top Glove and Supermax, which are largely latex-centric with a product mix of nitrile and latex estimated at 50:50, are expected to face margin pressure.
According to our analysis, there are nascent signs indicating that oversupply concerns appear overplayed considering that capacity expansion of the four rubber glove players under our coverage is expected to be delayed and staggered. In the last two years, the sector has become a victim of its own success. The frantic pace of capacity expansion has resulted in a mild excess supply of rubber glove, leading to average selling price compression and flattish or lower profit for the past two quarters. However, with the rubber glove players becoming aware of the intense competition since four months ago, measures have been taken to mitigate the impact of competition, including: i) slowing new capacity expansion; ii) measures to maintain margins, including automation and other cost-reduction initiatives; and iii) intensifying sales efforts to penetrate emerging economies.
Our top pick of the sector is Hartalega. We like the company for: i) its “highly automated production process” model, which is moving from “good” to “great” as it is head and shoulders above its peers in terms of better margins and reduction in costs; ii) it is constantly evolving via innovative product development; and iii) its nitrile glove segment is booming. Our target price (TP) is RM5.85 based on unchanged 36 times estimated CY20 earnings per share (EPS) at +1 standard deviation (SD) above its five-year historical forward mean.
We maintain “outperform” on Kossan. We like the company because it is trading at an unwarranted 28% discount to its peers’ price-earnings ratio average considering that its net profit growth is the highest at 23.7%, compared with its peers’ average of 7%. Our TP is RM5.25 based on 25.5 times estimated FY20 EPS at +1SD above its five-year historical forward mean. — Kenanga Research, Oct 2