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This article first appeared in The Edge Financial Daily on July 16, 2019

Glove sector
Maintain neutral:
On July 12, 2019, Gas Malaysia Bhd — with a “buy” call and target price (TP) of RM3.11 — announced that the government has approved the revision of natural gas tariff for the non-power sector in Peninsular Malaysia from July 15 to Dec 31, 2019. The tariff revision is in line with the national rationalisation plan and gas cost pass-through (GCPT) mechanism including the revision of piped gas prices every six months as indicated by the Energy Commission. Hence, the average effective gas tariff will be revised upwards by RM1.74 to RM34.66 per million British thermal units (MMBtu).

On annual gas consumption, major glove players fall within categories F and L — above 200,000 MMBtu. In addition, natural gas constitutes about 13% of the total glove production costs for all four glove manufacturers under our coverage. Hence, according to our calculations, this revision will have an impact on earnings of about less than 5%, especially for the third quarter of calendar year 2019 (3QCY19) performance. Nonetheless, we expect glove prices to be revised from September 2019, in line with the cost pass-through in the industry whereby a cost increase will be shared with customers.

We are maintaining our recommendations, earnings estimates and TPs of the glove producers under our coverage for now. To keep operating costs at bay, we take comfort in knowing glove manufacturers are actively looking at ways to reduce escalating energy and labour costs. For now, we view medium-sized glove manufacturers positively as they catch up on capacity and improve plant efficiency with bigger manufacturers.

Despite a thinning profit margin due to pricing pressure, Kossan Rubber Industries Bhd (“buy”; TP: RM4.53) and Supermax Corp Bhd’s (“buy”; TP: RM2.07) new plants will be equipped with energy-efficient and highly automated production lines. Coupled with a significant increase in production volume, we expect their profit margins will improve going forward. Moreover, both stocks trade at a more attractive valuation compared with those of their bigger peers. As such, we recommend investors to accumulate the stocks on weakness. — MIDF Research, July 15

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