Malaysian banks cheaper than glovemakers as mania continues

This article first appeared in Capital, The Edge Malaysia Weekly, on May 18, 2020 - May 24, 2020.

The PE valuations for the four big glove companies — Hartalega, Top Glove, Kossan Rubber and Supermax — have reached lofty levels, with multiples ranging from 43.60 times to 75.02 times

Photo by Bloomberg

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TYCOONS Kuan Kam Hon and Tan Sri Lim Wee Chai, both of whom are probably on top of the world now, would not have imagined that their rubber glove companies could be more valuable than banks.

The market capitalisation (market cap) of nitrile glove manufacturer Hartalega Bhd, founded by Kuan, is RM31.11 billion and has exceeded that of most of the local banks, except for Malayan Banking Bhd (Maybank), Public Bank Bhd and CIMB Group Holdings Bhd.

In fact, Hartalega’s market cap is more than the combined market cap of five banks: Affin Bank Bhd; Alliance Bank Bhd; MBSB Bank, which is owned by Malaysia Building Society Bhd; AmBank, which is owned by AMMB Holdings Bhd, and Bank Islam, owned by BIMB Holdings Bhd.

Likewise, the market cap for Lim’s Top Glove Bhd, in which he owns 35.95%, has soared to RM26.41 billion, larger than that of some of the bluest blue chips, including IOI Corp Bhd, Petronas Dagangan Bhd and PPB Group Bhd.

Even the market cap of Kossan Rubber Industries Bhd and Supermax Corp Bhd have exceeded that of some of the local banks even though the banking business is far more capital-intensive than the manufacturers and the barriers to entry are much higher.

Affin Bank, for instance, is the smallest bank in terms of asset base. Yet, the group’s asset management business Affin Hwang Asset Management Bhd alone is worth at least RM1.5 billion, based on its assets under management of more than RM56 billion as at end-2019, compared with its market cap of RM3.04 billion.

It is not surprising that both Hartalega and Top Glove have outperformed the other 28 component stocks of the FBM KLCI in terms of share price performance year to date, as the rubber glove sector is the rare bright spot on Bursa Malaysia amid the Covid-19 pandemic and the meltdown on crude oil prices.

Last Monday (May 11), Singapore-listed Riverstone Holdings Ltd released a stellar set of financial results. The Malaysian-based glovemaker’s quarterly earnings surged almost 54% to a record high of RM46.6 million, reinforcing the optimistic industry outlook.

The big leap in profit instantly added fuel to the share price rally among the rubber glovemakers listed on Bursa Malaysia.

More significantly, there have been news reports on the resurgence of coronavirus cases in Seoul and Wuhan, the location of the first outbreak, and other parts of China after their lockdowns were loosened.  The World Health Organization last Wednesday warned that the Covid-19 virus may never go away and would become an endemic virus in the communities. This will mean a high demand for rubber gloves for a longer period.

The price-to-earnings (PE) valuations for the four big glove companies  in Malaysia — Hartalega, Top Glove, Kossan Rubber and Supermax — have reached lofty levels, with multiples ranging from 43.60 times to in 75 times.

Interestingly, as the glovemakers’ share prices continue their ascent, investment analysts have raised their target prices (TPs) by as much as 80% to factor in as much positive news as possible in the absence of better news in other sectors.

Several analysts say their TPs are justified, given that their PE valuation assumptions are still below the historical peak PE valuations based on their substantially higher forecast earnings for the year.

The pandemic has resulted in a surge in demand for rubber gloves and other personal protection products such as face masks and hand sanitisers, as more than half of the world’s population — not just the medical workers on the frontlines — are using these products daily.

Some argue that the lofty valuations are justified in view of the immense increase in disposable rubber glove consumption for protection purposes.

RHB Research analyst Alan Lim expects Top Glove to deliver a strong set of third-quarter results (3QFY2020), with its profit to jump 85% quarter on quarter to RM215 million.

His optimism is based on four factors: higher average selling prices (ASPs) driven by the tight demand-supply dynamic, strong volume growth, favourable foreign exchange, and lower raw material prices, particularly butadiene.

Lim also highlights that the impact of higher ASPs is a powerful boost to the bottom line, given little increase in production costs.

It is worth noting, however, the capacity constraints that glove manufacturers could be facing as they receive brisk orders from around the world. Most are expected to be at full utilisation levels already.

The high demand would be a strong temptation for new entrants to grab a slice of the pie, considering that the barriers to entry are not very high. An oft-cited example is face mask production in China.

To buy into a rich valuation would imply betting on the glovemakers’ ability to continue churning out high profits and fending off competition for a prolonged period of time.


Gloomy days for banks

Being the proxy to economic growth, banks have fallen out of favour. The current harsh economic climate gives rise to concerns over their asset quality as non-performing loans begin to creep up.

Nonetheless, Bank Negara Malaysia has given its assurance that the country’s banking system is far more resilient than it was during the 1998 Asian financial crisis.

“There is certainly no question that the banking system today is far more resilient than at any time in its history. A lot of it has been because of reforms we have put in place after the Asian financial crisis — that was a bitter pill for us and we took major steps to reform the banking system, but we didn’t stop there,” the central bank’s deputy governor Jessica Chew told The Edge in an exclusive interview recently.

“We believe the reforms were good for the banking system and they will stand us in good stead for exactly a situation like what we are in now. It does put us in a [better] position to endure quite a bit of pain ... probably a substantial amount of pain.”

The domestic banking sector had a total capital ratio of 18.4%, according to data in 2019. The sector has excess capital of RM121 billion versus RM39 billion in 2008 and is capable of withstanding potential credit and market losses.

The sector recorded a common equity tier-1 capital ratio of 14.4% and gross impaired loan ratio of 1.6% as at February this year. There is ample liquidity as reflected by the liquidity coverage ratio of 148%.

The loan loss coverage ratio stood at 125% at end-February compared with an average of 120% from 2015 to 2019.

Some of the banks are currently trading at lower price-to-book valuations than during the 2008/09 global financial crisis, based on Bloomberg data.

Maybank is trading at a price-to-book value of 1.02 times; Public Bank, 1.37; Hong Leong Bank, 1.06; RHB Bank, 0.73; AMMB Holdings, 0.48; BIMB Holdings, 0.95; Alliance Bank, 0.55; and Affin Bank, 0.33.

The widening market cap gap between the glove manufacturers and banks have raised eyebrows as well as the question of whether market valuation has become irrational, as some see the world as being in uncharted territory.

Are the price premiums on glove manufacturers too high, or are the banks at bargain-basement prices?

A random simple sensitivity test, assuming glovemakers’ net profit will double because of the overwhelming demand, still puts their PE valuations at frothy levels ranging from 21.80 times to 37.51 times. By the same token, the glove bulls may say that historical valuation might not be a good yardstick.

As for banks, hefty non-performing loan provisions could drag them into losses as they bite the bullet to undertake a fresh round of kitchen sinking, say analysts, noting that banks’ margins are expected to be thin. Furthermore, they are unlikely to be able to sustain their dividend payouts.

All said, should one take Bank Negara’s word for it, that banks will be able to withstand the current downturn. What is a worse thing that could happen to a bank that the current market price has not factored in?


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