Glove sector
Maintain market weight on the sector. As expected, third quarter of 2014 (3Q14) aggregate sector earnings declined 4.2% quarter-on-quarter (q-o-q) [-17% year-on-year], largely dragged down by Hartalega Holdings Bhd’s weaker 2Q of financial year 2015 (2QFY15) performance (2QFY15 net profit plunged 15.6% q-o-q due to the rebound in nitrile raw material costs). Meanwhile, Top Glove Corp Bhd reported an 8.3% q-o-q rise in 4QFY14 net profit thanks to a lower average latex price of RM4.44 per kg (3QFY14: RM4.65/kg) and a much lower effective tax rate of 3.1% (3QFY14: 20%). Only Kossan Rubber Industries Bhd’s results fell short of our estimates, as 3QFY14 net profit was flat q-o-q due to delays in the commissioning of two plants.

Top Glove reported a subdued 3% q-o-q increase in sequential sales volume (vs 6.2% in 3QFY14) as its customers opted to run down inventory in view of the softening latex prices (-4.5% q-o-q). Meanwhile, Hartalega’s sequential sales volume (-1.4%) was largely dragged down by a 1.9% q-o-q decline in nitrile glove sales, although this was partially offset by a pickup in latex gloves sales (+4.3% q-o-q).

While Hartalega would typically pass on the full cost of the nitrile raw material price increase, this time round, the group continued to revise down its nitrile glove average selling prices (ASPs) to US$27.81 (RM97) per 1,000 pieces in 2QFY15 (1QFY15: US$28.34/1,000 pieces, despite the higher nitrile raw material costs of US$1,052/tonne in 2QFY15 (vs US$997/tonne in 1QFY15), thus resulting in a 3.5 percentage points (ppts) q-o-q contraction. Kossan, with an average 3Q14 nitrile glove production mix of 58%, was also not spared from the rebound in nitrile prices (although this was partially cushioned by the softer average latex cost), resulting in a subdued q-o-q margin contraction of 0.8ppt. We, however, note that Kossan’s would have upheld its margins, if not for the weaker operating leverage at its technical rubber products segment (-2.3 ppts q-o-q).

Reiterate market weight on the sector as rising headwinds (intensifying price competition and hikes in natural gas prices) within the industry may continue to weigh on share prices of most rubber glove companies.

In the near term, however, we see room for share prices of natural rubber glove players to appreciate if latex prices remain at the current depressed levels or decline further. We believe Kossan offers the safest bet for exposure to the glove sector on the back of its aggressive expansion into the production of higher margin nitrile gloves and improving production mix, which had sheltered the group from margin compression experienced by the rest of the industry.

Separately, we note that Top Glove could offer some near-term trading opportunity as it benefits from some temporary margin expansion arising from the time lag in passing on the weakening latex prices while its valuations lagged behind its peers’. As such, we upgrade Top Glove to a buy with an unchanged target price of RM5.08 (based on 15 times 2015 forecast price-earnings ratio).— UOBKayHian, Dec 8

This article first appeared in The Edge Financial Daily, on December 9, 2014.