This article first appeared in Capital, The Edge Malaysia Weekly on August 22, 2022 - August 28, 2022

ALL good things must come to an end. But in the case of glove stocks, the end is nowhere in sight as the sell-off has yet to abate, according to analysts.

Negative market sentiment intensified last week as several research houses recommended that investors trim their positions on the basis of “intense market competition” and “no signs of recovery”, among other reasons.

The downgrade came on the heels of a set of disappointing results by Hartalega Holdings Bhd that was below analysts’ expectations. While some analysts consider the stocks to be “oversold”, headwinds continue to spook investors.

As things stand, the intense selling pressure since the beginning of the year has resulted in a whopping RM31.87 billion being erased from the market capitalisations of the seven glove manufacturers listed on Bursa Malaysia.

The glove sector — the darling of investors at the height of the Covid-19 pandemic in early 2020 — is now suffering from a lack of interest. Even the share prices of the bigger players have been battered down as investors such as the Employees Provident Fund (EPF) trim their holdings.

Last week alone, EPF sold 36.87 million shares of Hartalega and disposed of 20.49 million shares of Kossan, thereby ceasing to be a substantial shareholder of the latter. The provident fund also ceased to be a substantial shareholder of the world’s largest glove maker Top Glove Corp Bhd on May 23.

The glove stocks have plunged considerably year to date. Top Glove’s share price is down 66.6% to 86 sen, Hartalega 67.4% to RM1.80, Kossan Rubber Industries Bhd 42.5% to RM1.04 and Supermax Corp Bhd 45.7% to 78 sen.

Other than the “big four”, Comfort Gloves Bhd has lost as much as 53.3% to 49.5 sen and Rubberex Corp (M) Bhd 11.5% to 46.5 sen.

Top Glove and Hartalega face the risk of being removed as constituent stocks of the FBM KLCI at the next review.

Analysts are not very sanguine about the glove sector as average selling prices (ASPs) have yet to bottom for a myriad of reasons, including an “abundance” of supply in the market, slowing demand and a decline in plant utilisation.

“The market is expecting glove manufacturers to see declining earnings in the next two to three quarters due to the downtrend in ASPs continuing as supply remains high,” Danny Wong, CEO of Areca Capital Sdn Bhd, tells The Edge.

He reckons that demand and supply in the glove market will stabilise by the end of the year as smaller glove players are expected to consolidate their operations or stop production entirely.

“In 2020, the industry also saw many new players coming in from every nook and corner around the world, not only in Malaysia. Some of the small players that did not manage to ride the glove boom may run out of cash to sustain their operations,” Wong points out.

On concerns of declining ASPs, CGS-CIMB Research says its channel checks show that glove makers, especially in China, are lowering their ASPs to be competitive in the market. “As such, we expect Malaysian glove makers, including Hartalega, to lower their ASPs to remain competitive in the near term,” it notes in a report.

A fund manager observes that in China, some producers are throwing prices at US$15 to US$16 per 1,000 pieces of gloves — a far cry from the local players’ prices of US$20 to US$22. However, an analyst is of the view that Chinese producers could have dumped prices because they may have limited markets to sell to because of China’s ongoing trade war with the US.

CGS-CIMB expects ASPs to stabilise by the end of the year at US$22 to US$24 before increasing to US$26 to US$27 in 2023. If so, ASPs would still be higher than pre-Covid-19 levels as gloves were fetching US$20 to US$22 at the time.

Worryingly, the report also stated that the “worst is yet to come” for glove makers such as Hartalega. The research outfit has downgraded its call to “reduce” from “hold” as current valuations have yet to account for the “weaker-than-expected earnings prospects” ahead.

CGS-CIMB expects Hartalega’s net profit for the financial year ending March 2023 (FY2023) to decline 96%. Interestingly, it projects earnings growth of 86% and 41% in FY2024 and FY2025 respectively.

As a result of heavy selling pressure, the valuations of glove stocks have touched record lows. Top Glove is trading at a 12-month forward price-earnings ratio (PER) of 22.76 times, Hartalega at 16.36 times, Kossan at 11.95 times and Supermax at 2.90 times. This is in stark contrast to their lofty valuations of more than 50 times at the height of the pandemic in 2020.

Rakuten Trade head of equity sales Vincent Lau reckons that glove stocks may be “oversold” and there are pockets of trading opportunities. He points out that the big players are sitting on large piles of cash, which will help to sustain their operations and dividend payouts.

However, the gross under-utilisation of capacity is a real concern. According to channel checks, some of the glove players are operating their plants at 40% to 50% of their current capacity, and that overcapacity issues may remain for the next one to two years.

“High raw material prices could impact their margins, but we expect the glove manufacturers to pass the cost on to their customers. The uncertainties in the glove sector remain until the ASPs find a bottom,” says Lau.

Fund managers contacted by The Edge say they are not inclined to invest in the sector in the short term, but they believe the long-term fundamentals remain intact.

“Some of the glove companies are sitting on a huge war chest that was built in 2020 during the rally in the global glove prices caused by the Covid-19 pandemic,” observes a fund manager. “Under this current market, cash-rich companies can embark on mergers and acquisitions, share buybacks or dish out special dividends to shareholders.”

Of the “big four”, Kossan and Supermax have the largest cash positions. Kossan has RM2.2 billion in cash, or 87 sen per share, while Supermax has RM2.97 billion, or RM1.11 per share.

“Supermax and Kossan look attractive at the moment, coupled with their low single-digit valuations. We believe that even though the ASPs are expected to decline further this year, glove makers are unlikely to report quarterly losses,” says another fund manager.

“The industry could see a turnaround next year if more small players consolidate to address the oversupply issues. We also expect the demand for gloves to be at 6.8% annually, which is higher than pre-pandemic levels.”

The Malaysian Rubber Glove Manufacturers Association (Margma) has forecast that global demand will see a recovery in 2023, after a 19% contraction this year to an estimated 399 billion pieces from 492 billion in 2021. For 2022, the association has cut its demand forecast by 12% to 399 billion pieces, from an earlier forecast of 452 billion pieces.

Public Invest says in a report that Kossan has the room to pay out higher dividends to its shareholders. “Although management intends to maintain its regular dividend payout ratio at 30%, we believe there is still room for a special dividend.

“Given the delay in capacity expansion, while its automation and transformation plan is not likely to cost more than RM100 million a year, Kossan has sufficient reserves to reward its shareholders.”

Hartalega and Top Glove have RM2.03 billion and RM485.5 million in cash respectively, although the latter has embarked on aggressive share buybacks since last year that have eaten significantly into its cash pile.

While the outlook for the sector currently appears bearish because of the many uncertainties, glove players that strengthened their balance sheets during the boom should be able to weather the storm and see better days in the long run.

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